CASE STUDY - European Commission · This case study looks at the experience of the MDGs in a middle-income ... BRICS Brazil , Russia, India ... case studies commissioned as inputs

Peru Case Study

Peru: Great Progress, Greater Challenges

CASE STUDY

Roxana Barrantes (Instituto de Estudios Peruanos) and Julio A. Berdegué (Rimisp-Centro Latinoamericano para el Desarrollo Rural)

DisclaimerThe content of this case study does not reflect the official opinion of the European Union or of its Member States. Responsibility for the information and view expressed lies entirely with the authors.

Peru Case Study


Synopsis

This case study looks at the experience of the MDGs in a middle-income country. It reviews the development achieved in Peru, the remaining challenges on issues or poverty and inequality as well as environmental sustainability and governance. It concludes by saying that beyond 2015, development will largely be about MICs facing some old challenges and many new ones; therefore, making use of and mobilising newly acquired resources and capacities of a different nature will be key.

MOBILISING EUROPEAN RESEARCHFOR DEVELOPMENT POLICIES


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Acknowledgements

This commissioned case-study report is largely based on five papers prepared by the following distinguished Peruvian colleagues:

Elmer Cuba, an economist at Macroconsult, whose paper on growth and employment is the source of Section 2.1.

Carlos De los Ríos, an economist at the Instituto de Estudios Peruanos (IEP), whose paper on poverty and inequality underpins Section 2.2.

Alan Fairlie, economist and Dean of the Faculty of Social Sciences of the Pontifical Catholic University of Peru (Pontificia Universidad Católica del Perú – PUCP), whose paper on Peru-European relations provides much of the basis for various parts of Section 2.

Manuel Glave, an economist with the Group for the Analysis of Development (Grupo de Análisis para el Desarrollo - GRADE), is the author of the paper on environmental sustainability on which Section 2.3 is based.

Martin Tanaka, a political scientist also at the Instituto de Estudios Peruanos (IEP), whose paper on governance is the source of Section 2.4.

Much of the text is copied or abridged from these papers. In addition, these colleagues and 23 other specialists from government, civil society, the private sector, academia and the media, as well as from the Delegation of the European Union in Peru, the Overseas Development Institute (ODI) (Emma Samman, Alina Rocha Menocal and Raphaëlle Faure) and the European Centre for Policy Development Management (ECDPM) (Paul Engel), participated in a one-day workshop that generated and fostered debates on many of the key ideas presented in this case study.

Andrea Sánchez and Ricardo Fuentealba assisted in various ways.

While acknowledging all of these contributions we take full responsibility for the contents of this case study.

Roxana Barrantes and Julio Berdegué.


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Contents

Acknowledgements i Contents ii Tables & Figures iii Abbreviations iv

1. Introduction 1

1.1. Peru, a middle-income country 1 1.2. Peru: economic and political context 2 1.3. Peru’s external links 4

2. Development in Peru in Key Areas 7

2.1. Growth and employment 7 2.2. Poverty and Inequality 14 2.3. Environmental sustainability 23 2.4. Governance 31

3. Conclusions 40

References 43


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Tables & Figures

Tables

Table 1.1 World population and GDP by country income classes, 1990–2010 2 Table 2.1 Profile of individuals in the Economically Active Population 11 Table 2.2 Evolution of poverty rates in Peru, 1985–2011 15 Table 2.3 Main actions in 2009 of the strategic thematic area of the PNCTI: sustainable competitiveness 26

Figures

Figure 1.1 Foreign Direct Investment (Million US$) 5 Figure 1.2 Peru: Remittances by Country of Origin, 2005–2009 6 Figure 1.3 External remittances (Billion US$) 6 Figure 2.1 Inflation and Economic Growth in Latin America (2001–2011) 7 Figure 2.2 Economic Growth in Latin America, 1991–2011 8 Figure 2.3 GDP per capita in Peruvian Departments by thirds (US$PPP) and national GDP per capita average for Chile, Peru and Bolivia 12 Figure 2.4 National monthly per-capita income (nominal Soles) and number of households 13 Figure 2.5 Current economy size and GDP increase 2011–2021 (billion US$, adjusted by PPA) 13


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Abbreviations

APCI Agencia Peruana de Cooperación Internacional

ASEAN Association of Southeast Asian Nations

BCRP Banco Central de Reserva del Perú

BID Banco Interamericano de Desarrollo

BRICS Brazil, Russia, India, China and South Africa

CCT Conditional Cash Transfers

CEMLA Centro de Estudios Monetarios Latinoamericanos

CNE Consejo Nacional de Educación

EAP Economically Active Population

ECDPM European Centre for Policy Development Management

EIA Environmental Impact Assessments

EPS Entidad Prestadora de Servicios de Salud

ERD European Report on Development

EU European Union

FAO Food and Agriculture Organization

FDI Foreign Direct Investment

FONCODES Fondo de Cooperación para el Desarrollo

GDP Gross Domestic Product

GRADE Grupo de Análisis para el Desarrollo

IADB Inter-American Development Bank

IEP Instituto de Estudios Peruanos

IFAD International Fund for Agricultural Development

IMF International Monetary Fund

INABIF Programa Integral Nacional para el Bienestar Familiar

INEI Instituto Nacional de Estadística e Informática

IOM International Organization for Migration

IUCN International Union for Conservation of Nature

JBIC Japan Bank for International Cooperation

JICA Japan International Cooperation Agency

LA 7 The seven largest countries in Latin America

LIC Low-income country

LMIC Lower-middle income country

LUP Land Use Plan

MDGs Millennium Development Goals

MEF Ministry of Economy and Finance

MIDIS Ministry of Development and Social Inclusion

MINAM Ministry for the Environment

MRTA Movimiento Revolucionario Túpac Amaru


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NGO Non-governmental organisation

ODI Overseas Development Institute

OECD Organisation for Economic Co-operation and Development

PCM President of the Council of Ministers

PLANAA Environmental Action Plan

PNA National Environmental Policy

PRONAA Programa Nacional de Asistencia Alimentaria

PUCP Pontificia Universidad Católica del Perú

RBB Results-Based Budgeting

RIMISP Latin American Center for Rural Development

SAE Strategic Environmental Assessment

SERVIR Autoridad Nacional del Servicio Civil

SINIA Sistema Nacional de Información Ambiental

SIS Sistema Integral de Salud

SNGA Sistema Nacional de Gestión Ambiental

SNIP Sistema Nacional de Inversión Pública

SSA Sub-Saharan Africa

SUNAT National Tax Bureau

UK United Kingdom

UMIC Upper-middle income country

USA United States of America

WEF World Economic Forum


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1. Introduction This report on the recent development of and future challenges facing Peru is one of four national case studies commissioned as inputs to the European Report on Development 2012---2013 ‘Development in a Changing World: Elements for a Post-2015 Global Agenda’ (ERD).

The ERD aims to provide an independent European contribution to the emerging debate on a possible post-2015 framework on international development. In doing so, it will seek to answer the three main questions identified by the Steering Committee:

What are possible elements of a global agenda that would help to focus efforts on poverty eradication over the next decades?

What would the poorest countries need and want, if anything, from a new global framework on development?

What can Europe contribute?

The outline of the ERD (ODI et al. 2012: 1) focuses on one central research question:

Which elements of a post-2015 framework --- including contributions of the European Union --- could support poor countries' efforts to overcome development constraints and create opportunities for (inclusive and sustainable) development?

The core of this question concerns the experience of developing countries and how they expect to continue tackling the eradication of poverty. A key secondary element is the support they might find useful from a new global framework on development. The ERD will examine in particular what the EU might best contribute to this framework.

1.1. Peru, a middle-income country The title of the ERD points to a changing world. It seeks to highlight the need for a global consensus on development that will continue to be pertinent in the decades following 2015. This is in contrast to the consensus embedded in the Millennium Development Goals (MDGs), which reflects the world as it was perceived by the preceding generation. One defining aspect --- in which the world has changed and will continue to do so --- is that middle-income countries (MICs) will dominate the future landscape of the so-called developing world. In the 1990s, development was concerned with poor countries overcoming quite basic human development challenges with few resources and capacities of their own. Beyond 2015, however, development will largely be about MICs facing some old challenges and many new ones, making use of and mobilising newly acquired resources and capacities of a different nature.

Of the four case studies, Nepal and Rwanda are low-income countries (LICs), Côte d'Ivoire is lower-middle-income country (LMIC), and Peru is an upper-middle-income country (UMIC). Nepal, and to a lesser extent Rwanda, most closely represent the developing world as it was in 2000 when the international community approved the MDGs. Côte d'Ivoire, and to a larger extent Peru, provide a glimpse of what the developing world will look like in the years to come.

Table 1.1 shows the growing importance of MICs since the 1990s. With a constant share of the world’s population of around 72% since 1990, they have doubled their contribution to the global Gross Domestic Product (GDP), and in 2010 they were responsible for about one-third of the total global economic output. High-income countries (HICs) have experienced a slow decline in their share of the population, but a drop of about 20% in their contribution to global GDP. What is perhaps more telling is that these changes have only begun to take place over the past ten years. This means that


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when the international community ratified the MDGs in 2000, the dominant image of the developing world was largely one of stagnation.

Table 1.1 World population and GDP by country income classes, 1990–2010

Country classification Population (%) Gross Domestic Product (%)

1990 2000 2010 1990 2000 2010 High-income countries 18.5 17.2 16.4 83.1 81.8 68.2Middle-income countries 71.9 72.3 72.0 16.2 17.7 31.1Low-income countries 9.6 10.6 11.6 0.7 0.5 0.7All countries 100.0 100.0 100.0 100.0 100.0 100.0

Source: Developed by the authors using data from the World Bank (data.worldbank.org)

Peru exemplifies very well the new and fast-changing developing world, one which is growing economically even in the midst of a global crisis, while very rapidly reducing poverty and overcoming many of the challenges highlighted in the MDGs. In 2012 there are 94 MICs like Peru in Africa (33), Asia (33) and Latin America (28), while there are only 36 LICs like Rwanda and Nepal (of which 27 are in Africa, eight in Asia and one in Latin America). Even in Sub-Saharan Africa (SSA), there are 27 LICs and 20 MICs, seven of which are in the UMIC sub-category.

Even poverty is no longer a phenomenon concentrated in low-income countries. Recent research shows that 72% of the world’s poor lives in middle-income countries. This stands in sharp contrast with two decades ago when almost all of the world’s poor lived in low-income countries (Sumner, 2012a, b).

The changing social and economic landscape of an increasingly middle-income developing world is translated into the realm of international development politics. At the time when the MDGs were ratified in 2000, the G-7 was the dominant force in international affairs. While Europe and the other OECD countries continue to play an important and powerful role, any significant international decision today requires the support and commitment of other groupings, in which the faces of the leaders of MICs are prominent, including the G-20, the BRICS, and the ASEAN, all of which were created relatively recently.

This is excellent news because it tells us that the developing world is on the move! Unfortunately, this reality has not yet registered in the behaviour and decisions of the development establishment in international organisations and in OECD countries, which by and large continue to drive into the future still looking in the rear mirror.

Yet, as we will show in this case study, middle-income countries --- and Peru in particular --- continue to face large and complex development challenges. In fact, these countries demonstrate some features and trends of rich and developed countries while sharing others that are characteristic of the very poor and least-developed countries. Some of these problems and challenges are structural and are legacies from the past. Others have emerged or grown in importance as a direct result of the overall progress experienced throughout the last 10 to 15 years. The MICs of Latin America, Asia and Africa may not be poor on average but they are still far from being developed. This is the crux of our report.

1.2. Peru: economic and political context

After a dismal second half of the 1980s and early 1990s, Peru’s economy began to grow steadily after two events that marked 1992. First, President Fujimori shut Congress down in April. And then the leaders of the two rebel groups that started the armed conflict that had ravaged Peru from 1980 were jailed. The political processes necessary to restore investor confidence called for a new social order, which was brought about by the enactment in 1993 of the Constitution by the ad hoc Constitutional


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Congress convened as a transition to restore democratic rule and approved by referendum. The 1993 Constitution, as it is commonly known, sets out the rules under which economic activities are conducted in Peru. The Constitution has undergone only minor amendments, despite loud calls for change. No political coalition has so far been able to change it or even to modify the main clauses relating to incentives for private investment, in order to restrict them.

Since 1994, the Peruvian economy has grown at an average yearly rate of 5.5%, slowing down only as a result of international financial crises, but rapidly rebounding. In 1998, the banking system was affected by the Asian crisis, but the economy returned to its growth path in 2002. In 2008, another international financial crisis affected the Peruvian economy but only slightly during three trimesters before a rapid recovery in 2009. This growth was led by the mining boom, from which several countries benefited during the last decade, mainly fuelled by China’s spectacular economic growth. Initially considered as an excellent redistribution mechanism, because it brought public resources closer to the people living nearby mining operations, mining rents were automatically transferred to local and regional governments that were permitted to spend the resources only on capital goods and services. As we shall see later, inefficient public management by local and regional governments meant that the redistribution of mining rents fell short of expectations.

During this period, redistributive policies relied on a ‘trickle-down’ effect and social policies were implemented through programmes that were increasingly aimed at assisting the extremely poor. At the same time the middle class was growing, and with it the notion that hard-earned assets could be lost if left-leaning political groups were to win an election.

Although Peruvians complain about growing inequality, and despite the fact that during the last two elections a leftist challenger reached the run-off and eventually won in 2011, Peru’s governments have maintained a strong continuity in macroeconomic policy. Widespread consensus on key macroeconomic fundamentals has persisted throughout three administrations: Toledo (2001---2006), Garcia (2006---2011), and Humala (2011---). Even the current President Ollanta Humala, who initially campaigned with a left-leaning agenda, had to adopt a more centrist discourse in order to reach the run-off elections in 2011, including an agenda for social support and economic growth as well as pro-growth and economic modernisation policies.

This interesting setting poses important challenges. Economic growth has occurred very quickly and structural and historical problems impinge on Peru’s ability to leap beyond the middle-income development trap. These challenges include poor education, scant public health coverage, unbelievably low (for its GDP per capita level) water and sanitation coverage and inefficiencies in the judicial system. Furthermore, the so-called ‘second-generation’ reforms are not a priority on the public policy agenda.1

Moreover, the ability of the public sector to deliver universal public services depends on the capacity of sub-national governments, which, in turn, relies on the respective regional presidents. Almost all sub-national governments receive automatic transfers of rents from the exploitation of natural resources generated in their jurisdictions either from mining, oil or gas. As mentioned above, these financial resources can be used only for capital expenditures on projects approved by the national project evaluation system administered by the Ministry of Economics and Finance (MEF). Since these direct transfers depend on the proceeds from the extraction of natural resources in the region, in which there is wide variation, the system creates serious imbalances in regional resources.

1 First-generation reforms are understood as those liberalising both goods and factor markets and privatising public services, while second-generation reforms pertain bringing efficiency into public goods provision: justice, universal public services, and institutional reforms.


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The political decentralisation process that began in 2001 is currently at a crossroads between those who want to consolidate it, and those who want to turn the clock back. In its origins, the democratisation process tried to spread power from the capital to the regions, and to calibrate the implementation of national policies to regional-specific characteristics. Results so far are heavily dependent on the quality of regional presidents, a feature that underlines one of our main conclusions, which is that institutional change will be essential in order for Peru to avoid the ‘middle-income trap’.

1.3. Peru’s external links This section provides some basic facts and figures about Peru’s external links, focusing on the period 1990---2011.

International trade has increased more rapidly than economic activity. Between 2000 and 2011, exports rose from US$6,955 million to US$46,268 million while imports rose from US$7,358 million to US$36,957 million. At the same time, the sum of exports and imports rose from 27% to 47% of GDP.

The export structure favours traditional products (mainly raw materials), which represented 78% of the total in 2011, while non-traditional exports made up the rest. This balance has remained consistent over recent years despite the boom in mineral prices. As for imports, capital goods represent 32% while inputs account for 49% of the total.

The economic reforms undertaken in Peru since 1990 were a response to decades of economic recession and growing macroeconomic instability. Multilateral agencies --- particularly the IMF, World Bank and the Inter-American Development Bank (IADB) --- played a decisive role in designing and financing a range of reform programmes that ultimately resulted in Peru’s return to economic sustainability. Over the past decade (and unlike the 1990s), the few structural reforms that have undertaken in various economic sectors have been implemented by local teams of professionals, which points to the existence of a cadre of highly qualified personnel.

The EU is an important player in the Peruvian economy. In 2012, Peru and the EU signed a free-trade agreement. This reflects confidence in the country and is a sign that trade flows will continue to increase, despite short-term problems in Europe. In relation to trade, in 2011 the EU was the destination of 22% of Peruvian exports and the origin of 15% of Peru’s imports. In that year, Germany, Spain, Italy, Holland and Belgium (in that order) bought 78.2% of all Peruvian exports to the EU as a whole. The same five countries were also the source of 63.8% of all of Peru’s imports from the EU.

The stock of Foreign Direct Investment (FDI) increased from US$5.06 billion in 1995 to US$22.02 billion in 2011. In 2011, mining represented 24% of total FDI, finance 18%, communications 17%, industry 14% and energy 13%. FDI has continued to grow, although the pace has slowed somewhat after the completion of processes of privatisations and concessions.

In 2011, the FDI stock represented 9.8% of total GDP, with Spain and the UK providing the main sources of investment (20% each) followed by the USA with 14%. Within the EU, the UK (39%), Spain (39%) and the Netherlands (13.4%) are the largest investors in Peru.


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Figure 1.1 Foreign Direct Investment (Million US$)

Source: BCRP (prepared by Macroconsult)

In Latin America, ODA from the EU and from bilateral European donors outstrips ODA from the USA. Multilateral agencies aside, the main European donors and the EU represent 41.6% and 14.5% respectively of all ODA in the region. During the last decade, the EU and European bilateral donors provided 11.4% and 58.2% of total non-reimbursable funds Peru received as ODA, while the USA provided 19.9%. According to ProInversion statistics, FDI in Peru increased rapidly from 2005 until the 2009 financial crisis when it dropped to approximately 20%. After 2010, FDI reached pre-crisis levels and was directed at sectors that have particular environmental impacts, such as the mining sector, which received 24.45% of total FDI in 2011.

Large numbers of Peruvians have emigrated, although recent figures show that the flow is decreasing. Despite this, the Peruvian government has no specific policies on migration. Given the international crisis, the government recently announced a plan to encourage Peruvians to repatriate, offering small tax breaks and subsidies.

The importance of ties with the EU is notable. According to the International Organization for Migration (IOM), approximately 30.7% of Peruvians residing abroad live in Europe, the second most popular destination after the Americas, in particular North America (34.8%). It is important to note that the majority of Peruvian women migrants live in European countries such as Germany, Spain and Italy, while men tend to move to neighbouring countries (IOM, 2010). Spain and Italy have become increasingly popular destinations in recent years. After the USA (32.6%), Spain has the second highest proportion of Peruvian immigrants (16.6%, mainly in Madrid). Argentina is home to the third largest community (13.5%) and Italy comes in fourth (10%). Peruvian migrants also ventured to new destinations between 1994 and 2009, such as the Netherlands (IOM, 2010).

CEMLA (2010) states that most of the Peruvian migrants living in Spain are students, office employees and professionals --- mostly teachers, engineers, company administrators and nurses. By contrast, most Peruvian migrants to Latin American countries, such as Chile, are students or work in the service sector.

The CEMLA report also indicates that according to a 2007 BID survey, of the 1.82 million Latin American immigrants in Spain, 126,000 (70%) were Peruvians, of whom 45% had lived there for more than three years. It is worth pointing out that although 64% of Peruvians residing in Spain pay social security, only 14% own their home.

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Remittances from Europe are sent primarily from Spain and Italy. Remittances from Spain more than doubled from US$174 million (2005) to US$372 million (2009), growing at an annual rate of 21%. Remittances sent from Italy rose from US$92 million (2005) to US$159 million (2009), an annual growth rate of 15%.

Figure 1.2 Peru: Remittances by Country of Origin, 2005–2009

Source: Banco Central de Reserva del Perú

In addition, migrants send remittances to their family. Since 1990, remittances have shown annual growth of 19% (INEI, 2011). In 2011, Peru received more than US$2.6 billion in external remittances, accounting for about 1.9% of total GDP. According to figures for 2009, 80% of remittances were sent from the USA, Spain, Japan, Italy, Argentina and Chile. About 66% of all remittances were used for household expenditures and 21% for education. Most families receiving remittances live in towns and cities, with more than 70% of remittances being delivered to the capital city, Lima (a region in the lowest poverty percentile). We estimate that without external remittances, national poverty would have increased from 27.8% to 28.2% in 2011.

Figure 1.3 External remittances (Billion US$)

Source: BCRP (prepared by Macroconsult)

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2. Development in Peru in Key Areas In this section we briefly review four development domains: growth and employment, poverty and inequality, environmental sustainability and governance. For each, we examine trends since 1990 as well as future development constraints and opportunities. We also discuss the role of external actors with an emphasis on the EU and on the instruments of trade and investment, aid and finance, and migration.

2.1. Growth and employment Since 2000, Peru has succeeded in achieving a deep transformation of its economic development strategy and its economic fundamentals. These changes have spurred vigorous economic growth and job creation and underpin Peru’s progress against a number of social indicators. This section will examine these processes in some detail.

2.1.1 Main changes since 1990

The Peruvian economy is characterised by macroeconomic stability. Between 2001 and 2010 Peru had, on average, the lowest inflation rate of the seven largest countries in Latin America, as well as the most dynamic economy (Figure 2.1). The hyperinflation that Peru experienced in the 1980s was instrumental in conveying a sense of urgency and need for action.

Over the past two decades fiscal accounts have also steadily improved, resulting in one of the lowest risk ratings in the region, along with Chile and Mexico. Public debt as a percentage of GDP dropped from 47% in 2003 to 21.7% in 2011. In the past, Peru’s economic policy traditionally followed a cyclical pattern: faced with an external crisis, external financing for the public sector was halted, leading to a fiscal adjustment that exacerbated the impact of the recession. However, thanks to the country’s current fiscal strength, despite facing an international crisis of equal magnitude to the 2008---2009 crisis, for the first time in decades the MEF responded with a public spending package of nearly 2% of GDP in order to break the cycle of recession

Figure 2.1 Inflation and Economic Growth in Latin America (2001–2011)

Source: IMF


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Meanwhile, external deficits (balance of payments and current account deficit), which once led to considerable adjustments in the exchange rate, are no longer part of the national macroeconomic profile. This has remained so even after the economy was unilaterally opened to trade and the government signed various free-trade agreements.

As a result of national economic policy and the performance of the global economy (described in the next section) Peru’s economic performance has been remarkable, especially over the past decade. Particularly noteworthy is the 2005---2011 period during which Peru registered an average annual GDP growth rate of 7%. Peru is one of the very few countries in Latin America whose economy has had higher than regional average growth rates during both of the past two decades (Figure 2.2).

It may therefore be argued that, after the major macroeconomic crises of the 1970s and 1980s, solid macroeconomic policies have become a type of public good that reflect a consensus in Peruvian society.

Figure 2.2 Economic Growth in Latin America, 1991–2011

Source: IMF

Employment

The economically active population (EAP) increased from 13.1 million in 2004 to 15.1 million in 2010, representing an annual growth rate of 2.4%. Average labour productivity has grown at an annual rate of 4.4%.

The unemployment rate in Metropolitan Lima dropped from 8.2% in 2004 to 5.7% in 2011. In general, unemployment is not currently a public policy concern, because the overall rate has fallen. The problem is that the average Peruvian works, but earns very little. The underemployment rate --- defined by hours or by income --- is therefore a more relevant indicator given the characteristics of Peru’s labour market. Underemployment by income is defined as workers who earn less than the cost of a basic basket (canasta básica) of goods and dropped from 71% of the EAP in 2001 to 54.6% in 2010.


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Decisive factors of change: national and international

This section discusses some of Peru’s remarkable achievements, and explores what national and international factors made them possible. What was the role of political leadership/the executive? Was there pressure from the private sector and/or organised civil society? How were reforms pushed through? What governance mechanisms made such changes possible? What was the role of the IFIs in all of this?

In the 1970s and 1980s, the Peruvian economy was one of the most volatile in the region. There were three episodes during which Peru stopped payments and made fiscal adjustments. Inflation rose from an annual average of 9% in the first half of the 1970s to 879% in the second half of the decade. In 1990, macroeconomic stabilisation (fiscal and monetary) and structural reform programmes were launched simultaneously and an ambitious opening-up of trade and finance began.

Until then, the state had tightly controlled the system of relative prices. With the new liberalisation agenda prices were left to the market. Tariffs and para-tariff barriers were gradually dismantled and many public enterprises were privatised. Regulatory bodies were created in the case of natural monopolies in energy, water, telecommunications and transport. A watchdog agency was also created to oversee free-market competition and consumers’ rights.

At the same time, the public debt was rescheduled, the tax-collection agency was strengthened and the fiscal deficit was reduced. The Central Bank (Banco Central de Reserva del Perú --- BCRP) was granted autonomy from the government with the single goal of ensuring monetary stability (which the issuing body interprets as price stability).

Over the past decade, the Ministry of Economy and Finance (MEF) has been governed by economic guidelines while the BCRP has followed a model of inflation goals. Each year, the MEF issues a Multi-Year Macroeconomic Framework of official projections for the Peruvian economy and for the main policies and targets in the public sector. This framework serves as a guide for the public budget. The Fiscal Responsibility Law sets a ceiling of 1% for the fiscal deficit and 4% for annual expansion of public expenditures, except for some minor line items. Public investment is subject to the lower percentage ceiling. The limits to increases in public spending have rarely been respected because of the high economic growth rates, and permission has been sought from Congress for an exception to the law. Nevertheless, the law has served as an indicator of deviation.

Every four months, the Central Bank publishes its Inflation Report containing the projections, the principal monetary policy measures and short-term inflationary risk factors.

Over the past decade, the strong global economy has also played a significant role in the positive performance of the Peruvian economy. Besides growing export demand, prices for raw materials have risen and foreign capital has arrived in the form of FDI and long-term debt.

Principal obstacles: national and international

The first major obstacle to continued economic growth is recurrent political crises. Economic growth leads to disputes about income distribution, which are reflected in the market, social conflicts and politics. In the last ten years there have been episodes that ended in political crises involving the replacement of the President of the Council of Ministers (PCM) --- the highest executive authority after the President --- and ultimately leading to a shake-up of the entire cabinet. Between July 2001 and July 2012, there have been 12 cabinets, each with an average life span of 11 months. Moreover, President Humala had to appoint three different PCMs in the first year of his presidency.

Nevertheless, thanks to the continuity of macroeconomic policy the economy has moved forward, with all the evident benefits. With a few exceptions, however, there has been little substantive change


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in other economic policies. If this pattern continues over the coming years, growth rates and social welfare could suffer.

International crises affect the economy because they lead to a decreased demand for Peru’s exports. Lower prices for raw materials also affect revenues. Likewise, the withdrawal of short-term capital affects the liquidity of the financial system. The first three impacts put pressure on rising exchange rates, while lower short-term business expectations affect private investment.

In general, the Peruvian economy can now redress some of these impacts thanks to the implementation of anti-cyclical macroeconomic policies, especially higher public spending and the injection of liquidity that also heads off a major devaluation. These measures help to counterbalance some of the impacts of the international recession, although Peru cannot insulate itself completely from the external environment.

2.1.2 Future constraints and opportunities

Despite its outstanding recent economic performance, Peru faces several major challenges in order to sustain this. In doing so, several opportunities can be leveraged.

Principal constraints that could affect future development

In order to avoid the economy being caught in the ‘middle-income trap’, the main challenges to be addressed are the poor effectiveness and inefficiency of public services, low productivity and international competitiveness, high levels of informality, large and persistent regional inequalities, and low government capacity for resolving social conflicts by democratic means and with full respect for human rights.

The first issue is the efficiency of the public sector. Peru has almost a million civil servants, but salaries and incentives have not resulted in higher standards of service. As an example, the population of over half of Peru’s departments has running water for an average less than 16 hours a day, not to mention its poor quality.

There is also the problem of the quality of expenditures. According to the MEF, only 20% of the 2012 budget is subject to a system of ‘Results-Based Budgeting’ (RBB), although this is expected to increase gradually.

Public investment is governed by the National Public Investment System (Sistema Nacional de Inversión Pública ---SNIP). In practice, however, public spending has been decentralised to poorly skilled project designers, evaluators and implementers. Most sub-national governments do not have the personnel to carry out public investments at the required pace and scale. There simply are not enough trained technical personnel.

The second major future challenge is the low competitiveness of much of Peru’s economy. In the main rankings of competitiveness, Peru lags behind the seven largest countries in the region. The World Economic Forum (WEF) and the World Bank’s Doing Business reports show that Peru’s infrastructure and institutions hve major shortcomings.


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Table 2.1 Profile of individuals in the Economically Active Population

Thousands of People

% of Total Population

Employment type Self-employed 6192 40.5 Employed 6709 43.8 Other 2406 15.7 Pension system Private pension (AFP) 3017 19.7 National pension (Law 19990) 1351 8.8 National pension (Law 20530) 138 0.9 Other 214 1.4 Unaffiliated 10602 69.3 Employer workforce size < 10 workers 10841 71.9 Between 10 and 50 1230 8.2 Between 50 and 100 332 2.2 More than 100 2671 17.7 Health insurance Essalud 3883 25.4 Private 361 2.4 EPS – Private Health service providers 135 0.9 Armed forces/police 273 1.8 SIS – Integral health insurance 4772 31.2 University 40 0.3 Student 1 0 Other 30 0.2

Essalud/EPS/Armed Forces/Police 6117 40 Unaffiliated 4194 27.4 Total 15307 100

Source: ENAHO 2011

Related to the question of economic competitiveness, but meriting a separate analysis, is the challenge posed by the magnitude of the informal economy. Although the concept of ‘informality’ in fact refers to illegality, in the economic sphere it represents low levels of business and labour productivity. Many micro-enterprises pay no taxes because their surplus is very small and taxation would jeopardise their very existence. Labour productivity is also very low in these businesses because of a lack of physical and/or human capital, which also limits their ability to comply with general labour laws in areas such as vacations, medical insurance and retirement.

Table 2.1 presents a closer look at the issue of informality. Well over two-thirds of all workers in Peru have no access to social security and about the same number either work in firms of under ten employees or independently. The self-employed and uninsured categories include those who are underemployed (according to their income) and indicates that this predicament affects over two out of every three working Peruvians.

Workers in informal and low-productive sectors face huge challenges that are not only economic in nature. For example, in 1990 the rate of chronic malnutrition among children was nearly 40% nationwide and reached 54% in some rural areas. This means that many people now entering the labour market are at a serious disadvantage, which will have a lasting effect on remuneration and well-


12

being. Fortunately, the rate of chronic malnutrition among children had dropped to 20% in 2011, although it remained high in rural areas (37%).

Figure 2.3 GDP per capita in Peruvian Departments by thirds (US$PPP) and national GDP per capita average for Chile, Peru and Bolivia

Another crucial challenge for development lies in the growing inequalities among Peru’s different regions. Peru has 24 departments, which form the basis for 26 political-administrative regions (Lima includes Lima Provinces, Metropolitan Lima and the Province of El Callao). Dividing the 24 departments into three groups according to their per capita GDP rates, the first group has shown a significant increase in per capita GDP with an average approximately equal to that of Chile (a new member of the OECD). The other two groups have a per capita GDP closer to that of Bolivia, one of Latin America’s poorest countries. In general, the top third includes all the coastal departments (except Tumbes and Piura) and the jungle region of Madre de Dios (where there is illegal gold mining). The other two-thirds include departments in the Andean highlands and Amazonian region (see Figure 2.3).

The fourth major challenge for economic development over the coming years is that of weak governance, particularly in relation to the prevention and management of social conflict according to the norms and standards of a democratic society and with full respect for human rights. The main concern lies in the area of socio-environmental conflicts between the mining sector and local communities.

Mining, by national and foreign-owned firms, plays an important role in the Peruvian economy. According to official statistics, mining represents 14% of total GDP. Excluding the GDP of the department of Lima, mining represents some 28% of regional economic activity. The sector’s ability to generate tax revenue and foreign currency is important for financing the development of better public policies. Mining projects expected to begin operations between 2012 and 2021 will generate investment of around US$42 billion according to the Ministry of Energy and Mines. Many of these projects are at risk, however, because of groups opposed to mining. This issue is explored in greater detail in Sections 2.3 and 2.4, which deal with environmental sustainability and governance respectively.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18 , 000

2005 2006 2007 2008 2009 2010 2011e 2012p

Chile

Bolivia

2nd Third

3rd Third

Peru

1st Third


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Principal opportunities to be leveraged

Despite these challenges, a number of new opportunities could help to sustain Peru’s economic development. The first is the expansion of the middle class as a result of economic growth over past years.

Between 2004 and 2010, GDP rose by an average of 7% annually and household consumption increased by 6.1%. As Figure 2.4 shows, a significant percentage of families have overcome poverty, while others have moved away from the poverty line. This creates a larger domestic consumer market, as well as hopes for a better standard of living for families and for the future workforce. Unfortunately, however, in rural areas a large percentage of families still live in poverty.

A second opportunity is represented by the strong demand from emerging economies for the goods that are produced competitively in Peru. Over the next ten years, emerging economies will produce the most value-added goods worldwide. According to the BBVA’s EAGLES (emerging and growth-leading economies) ranking, these countries will make the greatest demand for raw materials and food, as well as other goods (Figure 2.5).

Figure 2.4 National monthly per-capita income (nominal Soles) and number of households

Source: ENAHO 2004 and 2010

Figure 2.5 Current economy size and GDP increase 2011–2021 (billion US$, adjusted by PPA)

Source: BBVA, 2011b

GDP 2011, 26,122

GDP 2011, 29,700

GDP 2011,6,733

GDP increase,

23,550

GDP increase, 6,309

GDP increase, 4,171

EAGLES G7 Nest


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Peru has a competitive advantage due largely to the potential of the mining sector and to coastal irrigation projects for large-scale food production. Current investment in mining projects that are expected to begin operations between 2012 and 2016 amounts to US$27,191 billion, while those expected to start between 2017 and 2021 amount to nearly US$15,548 billion.

With respect to the future economic development of Peru, it is easy to see where the international community (both the public and private sectors) could play an important role.

Peru’s public services have not kept pace with its macroeconomic indicators. Even within the context of economic growth and modernisation, the tax effort excluding mining increased by barely 0.6% of GDP between 2005 and 2011. In order to bolster competitiveness, the national economy needs more resources to improve public infrastructure and basic services such as education, health care, public safety and justice.

Given Europe’s high standards in relation to taxation and public services (the European civil service has world-class standards), there is significant potential for the EU to contribute to improvements in Peruvian public services via technical cooperation agreements with various ministries and public agencies.

Impact of the Millennium Development Goals (MDG) Framework on the design and achievement of national objectives

The MDGs have not played a significant role in economic reforms, since these began back in 1990 well before the MDGs were developed. Over the past decade, each successive government has formulated its own goals and objectives. At best, the MDGs have had a minor influence on those plans but they are certainly not an issue in public policy or debate.

2.2. Poverty and Inequality

There is a growing consensus that poverty and inequality have to be assessed as ‘an expansion of human freedoms that people value and have reason to value’, and that ‘the role of incomes or expenditures… has to be integrated into a broader and fuller picture of success and deprivation’ (Sen, 1979). Although in Peru this approach is implicit in various policies and development programmes, indicators related to capabilities are not yet integrated into national statistics of poverty and inequality. This case study can therefore only assess the evolution of poverty and inequality in Peru on the basis of available information.


Poverty in Peru has fallen significantly since 1990, but structural inequality persists. We can divide the period since 1990 into two parts: 1985 to 1998 and 2001 to the present. During the early part of the first period, poverty increased dramatically as a result of the macroeconomic and hyperinflationary crisis. Between 1994 and 1997, poverty dropped slightly following the structural adjustment process. The deceleration of the economy between 1997 and 1998 (caused by the Asian economic crisis) caused poverty rates to rise once again. From 2001, Peru embarked on a long path of economic growth, which set the context for a sharp and sustained drop in poverty rates by 2011 to almost a half of 2001 levels.

Poverty lines in Peru are defined according to geographical location and urban/rural setting and adjusted yearly based on the average cost of living. In 2011 the poverty line for urban areas was US$3.59 per person/day and for rural areas, US$2.46 per person/day.2 Using this official definition, 27.8% of all Peruvians were poor in 2011, with an average of 18% and 56.1% in urban and rural areas respectively.

2 No Latin American country uses the World Bank benchmarks of $1.25 or $2 per capita ppp.


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One of the salient features of the dynamics of poverty in Peru is their heterogeneity. For instance, while the rural sierra (mountains), the urban coast and Metropolitan Lima saw the largest increases in poverty between 1985 and 1997, only the latter two have significantly recovered in the last decade. Despite some progress over the same period, poverty levels in the rural sierra have not yet returned to their 1985 levels.

The same heterogeneous patterns can be observed in assessing poverty dynamics at the regional level since 2000 (Table 2.2). For example, while the three better performing regions have reduced poverty by more than 70%, some other regions have shown less than a 25% reduction (INEI, 2012). Moreover, Escobal and Ponce (2008) demonstrated that although average poverty rates declined between 1993 and 2005, they actually rose in some rural provinces. However, a recent INEI study (2011) showed that rural poverty decreased at a higher rate than did urban poverty between 2007 and 2011. This positive trend in rural areas is largely explained by improved social policies and better prices for agricultural products.

Table 2.2 Evolution of poverty rates in Peru, 1985–2011

Source: LSMS 1985, 1997; NHHS 2001, 2007, 2011

Income poverty in Peru is concentrated not only in rural areas, but also among indigenous populations where the incidence is twice that of non-indigenous rates (45.7% and 24.1% respectively in 2011). Despite this, indigenous populations have experienced some important improvements with a recent drop in poverty of 22 percentage points in only seven years.

Poverty is also associated with lower levels of education and with low productivity, as most poor individuals are independent workers (43.8% against 32.7% of non-poor workers), employed in agriculture (56% in contrast to 17.8% of non-poor workers), or are unpaid workers (24.6% against 9.3% of non-poor workers). These conditions have not changed significantly over the last 20 years.

Peru has achieved important results in reducing the percentage of chronically malnourished children under the age of five, which dropped from 25.4% in 2000 to 17.9% in 2010. Although levels of malnutrition are twice as high in rural areas, both urban and rural areas have experienced similar rates of reduction. It is important to note that there is no difference in access to public health insurance between rural and urban areas since Integral Health Insurance is a government mechanism designed to provide health services to the poorest population. Furthermore, over the last 20 years, primary school attendance rates in rural and urban areas have become comparable. Despite important increases in the number of people obtaining access to health and education services, however, the quality of these services varies considerably.

1985 1994 1997 2001 2007 2011 1997/85 2011/01 2011/ 85

Urban Coast 42.1% 51.8% 58.3% 43.8% 31.7% 18.2% 38.5% -58.4% -56.8%Rural Coast 50.0% 63.4% 52.8% 62.0% 53.8% 37.1% 5.6% -40.2% -25.8%Urban Sierra 36.4% 51.6% 37.7% 50.5% 31.8% 18.7% 3.6% -63.0% -48.6%Rural Sierra 49.2% 64.7% 68.1% 82.9% 79.2% 62.3% 38.4% -24.8% 26.6%Urban Rainforest 48.2% 43.0% 44.2% 61.4% 44.0% 26.0% -8.3% -57.7% -46.1%Rural Rainforest 67.9% 70.1% 64.9% 73.0% 69.2% 47.0% -4.4% -35.6% -30.8%Metropolitan Lima 27.4% 42.4% 35.5% 31.2% 25.1% 15.6% 29.6% -50.0% -43.1%

National average 41.6% 53.4% 50.7% 53.9% 42.4% 27.8% 21.9% -48.4% -33.2%

LSMS NHHS Poverty Dynamics


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Latin America is the region with the world’s highest levels of income inequality, and Peru is one of the most inequitable countries in the region. Several studies agree that overall inequality in Peru has diminished slightly over recent years but that horizontal inequalities have risen. Jaramillo and Saavedra (2009) observed a significant fall in inequality between 1997 and 2006, which they attributed mainly to a shift in social expenditures favouring the poor, better access to public services, and the growing importance of non-labour incomes. In contrast, Yamada and Castro (2007) found inconsistencies in the evolution of inequality between 1997 and 2004, observing that while per capita income remained constant and income inequality dropped, poverty increased. They argued that the national household surveys underestimate the income of the richest percentiles. After correcting the inequality indicators, they showed a significant increase in income inequality but also a flatter trend of change. Escobal and Ponce (2011) made similar adjustments to per capita expenditure and noted a 3.8% reduction in the Gini coefficient for the period 1994---2009.

Escobal and Ponce (2008) developed a typology of provinces, according to observed changes in growth, poverty and inequality. They found that while about 20% of the population has experienced economic growth, poverty reduction and an increase in income above the national average, approximately 45% experienced economic growth and poverty reduction but lag behind in terms of income distribution. In addition, about 65% of the population is either experiencing economic growth at lower than average rates or is experiencing negative economic growth. The better-performing provinces are mainly in urban coastal areas or the central Amazon region, while the worst performers are mainly in the highland provinces.

Main drivers of change

Two main drivers of change are responsible for the sharp reduction in poverty that has occurred in Peru over the past two decades. The first is the elasticity of poverty to economic growth as measured by GDP. The second involves improvements in the quantity and quality of public spending on social programmes.

The relationship between economic growth and poverty reduction in Peru has historically been very limited. Between 2004 and 2007, however, there is evidence of a strong correlation between economic growth and poverty reduction. As noted above, monetary poverty has fallen, particularly in urban areas. Several studies have shown that improvements in urban employment rates between 2000 and 2004 were not reflected in poverty figures since the beneficiaries were mainly better qualified employees hired by large companies rather than informal employees from sectors where poverty is concentrated. Between 2004 and 2007, however, poverty dropped in marginal urban areas at almost twice the rate of non-marginal areas. Vakis and Clavijo (2008) developed two hypotheses for this phenomenon. First, following an expansion in informal market opportunities, most of the population in marginal urban areas reported receiving higher incomes as the main source of their improved welfare. Higher rates of public and private investment may also have boosted productivity, particularly in marginal urban areas, providing traditionally low-productivity activities with higher levels of technology and greater added-value (development of construction and export agriculture, for example). Second, secondary or higher education seems to be greater in marginal urban areas, especially for people working in the informal economy.

Another relevant factor in poverty reduction is the significant increase in the quantity and quality of public spending on social programmes. According to Mendoza et al. (2011), total social expenditures have risen from 4% of GDP in 1990 to about 9% over the past few years. The success in non-monetary poverty reduction is also related to increased public spending on infrastructure to expand universal access to public services such as rural roads (e.g. Provias Descentralizado), telecommunications, drinking water and sewage systems (e.g. Agua Para Todos), rural electricity (e.g. Programa de


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Electrificación Rural), education (e.g. Programa de Infraestructura Educativa) and rural development (e.g. Agrorural).

Other social programmes have been geared to specific groups of beneficiaries. Most of these were launched in the early 1990s as part of a compensation package for the structural adjustment programme and include the Fondo de Cooperación para el Desarrollo --- FONCODES (Development Cooperation Fund), Programa Nacional de Alimentación --- PRONAA (National Food Programme) and Programa Integral Nacional para el Bienestar Familiar --- INABIF (National Family Welfare Programme). The Sistema Integral de Salud --- SIS (Integral Health Programme) was established in 2002, and a conditional cash transfer (CCT) programme called JUNTOS was created in 2005, aimed at breaking the inter-generational transmission of poverty and building human capital in the poorest regions of rural Peru. This programme was inspired by successful CCT programmes in Mexico (Oportunidades) and Brazil (Bolsa Escola), and is an excellent example of successful South---South cooperation and learning.

Since the 1990s, improving the quality of social expenditures has been high on the public and policy agendas. The Comité Interministerial de Asuntos Sociales (Inter-Ministerial Committee for Social Affairs) was established to promote coordination among various sectors responsible for social issues. Unfortunately, the Committee never had sufficient political weight to be effective, since it was below a vice ministry in the government hierarchy.

Most social policy in the 1990s was implemented via programmes such as PRONAA and FONCODES, which distributed public funds to social interest groups on the assumption that economic growth would reduce poverty via a ‘trickle-down’ effect. Macroeconomic performance during the decade did not translate directly into a better quality of life for citizens, however, and serious questions were raised about the effectiveness of social policy. During the first decade of this century, the focus of social policy began to shift towards social inclusion.

In 2007, there was a major change in social policy with the merger of more than 80 programmes into 26, which improved efficiency. In July 2007, the government established the Estrategia Nacional CRECER, a national strategy for linking more than ten national programmes (including JUNTOS) with the aim of reducing chronic malnutrition in children under the age of three years. This strategy connected not only different programmes, but also different levels of government (national, regional and local). Finally, a strategic decision to improve the quality of social expenditure (and public spending in general) led to the creation of the Result-Based Budget (RBB) programme, which included measures to improve health, nutrition, productive infrastructure, access to public services and food security.

Main obstacles

Poverty reduction has varied across population sub-groups, typically associated with particular geographic (rural, high altitude) or socioeconomic characteristics (ethnicity, economic activity, gender, education, etc.).

Certain groups in Peru experience social, economic, political and/or cultural exclusion and discrimination. Several authors have shown that these factors have a direct effect on poverty and inequality. Figueroa and Barrón (2005) concluded that to a large degree, inequality is explained by economic exclusion. Torero et al. (2004) found that approximately 75% of income inequality is attributable to economic exclusion associated with the uneven quality of education and access to credit. Trivelli (2005) found that even if the allocation of assets between indigenous and non-indigenous populations were equal, the latter would still earn higher wages.

While Peru’s public spending on social programmes has been improved significantly, total resource allocation is still below the Latin American average. In 2008, while average social public spending in


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Latin America was nearly 18% of total GDP, in Peru it was barely above 8%; moreover, social expenditure per capita in Peru is just 25% of the Latin American average. Yamada and Castro (2007) showed that if Peru’s social expenditure as a percentage of GDP were equal to the Latin American average, inequality could drop by about 10%.

One obstacle to the reduction of poverty and inequality in a context of economic growth is related to the structure of the economy, which fails to promote strong linkages between economic sectors and regions. Most of the economic growth in the past decade did not benefit traditional low-productivity activities, such as agriculture. Similarly, historically poor regions lag behind the outstanding growth experienced by other provinces and regions.

A key barrier to poverty reduction in Peru is therefore persistent inequality in the economy. Vakis and Clavijo (2008) observed that poverty could have been reduced by a further 4% between 2004 and 2007 if there had been no adverse distributive effect. In addition, although growth in urban areas was large enough to compensate for the distributive effect, the poverty-reducing potential of rural growth was halved because of high inequality. Rural poverty would have dropped by an additional 11% had there not been an adverse distributive effect.

Uneven distribution of public infrastructure spending (rural roads, schools, medical centres, electricity, etc.) is another reason why poverty has not declined more in rural areas. As Escobal (2005) noted, there is evidence that regional income or expenditure differences can be explained by significant gaps in access to infrastructure and other public assets. Similarly, Escobal and Ponce (2011) argue that geographic inequalities between provinces stem from inequalities in access to public goods and services (beyond basic services), access to means of production, and inequalities in the exercise of citizenship.


The last decade has been characterised by strong economic growth that has contributed considerably to poverty reduction. One main challenge for future poverty-reduction efforts is to sustain the high growth rates of recent years far into the future. If monetary poverty continues to decline at the same average rate as the 2001---2010 period (2.3 percentage points per year), Peru will need at least another decade to reduce the national poverty rate to below 5%. The economic crisis in Europe could very well become a major impediment to Peru being able to sustain high growth rates over the coming years.

A significant challenge in any efforts to reduce poverty is the degree of heterogeneity among different sub-groups of the population. This is a structural problem which results in a concentration of poverty in rural areas, particularly the rural highlands with its thousands of small, isolated villages that lack basic public infrastructure. Poverty is also concentrated in rural households that rely on low-productivity activities, such as agriculture, as their main source of income. Poverty rates are also extremely high among rural indigenous populations who typically have low levels of education and larger families. Reducing poverty will depend on breaking down these structural barriers.

This heterogeneity also exists across economic sectors and regions. Chacaltana and Yamada (2009) show that although products per worker increased between 1993 and 2008, the ratio of the average product per worker in the most productive activity (mining) to that of the lowest (agriculture) increased from 19 to 21. In a macroeconomic analysis of regional GDP convergence, Del Pozo and Espinoza (2011) found evidence of greater inter-regional inequality. Similarly, Escobal and Ponce (2008) found that inequality between provinces increased between 1993 and 2005.

Another aspect to consider is that while economic growth is concentrated in high-productivity activities, employment is concentrated in low-productivity sectors. Industries with per-worker product exceeding US$40,000 a year (electricity, gas, mining), but which provide only a minimal


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percentage of national employment, co-exist alongside low-productivity activities (agriculture, tourism, services) which employ more than 70% of the population. Most workers are employed in small-scale companies that generate less than US$3,000 net income per year (Chacaltana and Yamada, 2009).

Likewise, Peru has both high-productivity (Moquegua, Arequipa and Lima) and low-productivity (Apurimac, Ayacucho or Huancavelica) regions, although there is considerable heterogeneity even within regions. For example, mining activities make Moquegua the most productive region despite the fact that the vast majority of its population is employed in less productive activities (agriculture and services). A major challenge for the future is to promote ad hoc incentives to enhance productivity in specific sectors in each region.

An important issue for regional development, as well as for reducing poverty and inequality, involves government transfers to local governments. According to several studies (Lavado, 2007; Gómez and Sepúlveda, 2008), the natural resource automatic transfer legislation has severely exacerbated pre-existing regional disparities (as discussed in Section 1.2). Gómez and Sepúlveda (2008) found that the current government transfer system does not reflect the fiscal capacity or expenditure needs of different municipalities. They also noted that capital transfers carry disproportionate weight, without the support of adequate current expenditures. Thorp and Paredes (2010) assert that where local governments lack the capacity to use these resources adequately, canon transfers can foster social conflict by failing to meet people’s expectations. A major challenge, therefore, is to ensure that government transfers constitute efficient resource allocation that improves the quality of life in local communities and also contributes to an integral development strategy.

A major constraint to poverty reduction is the lack of adequate public infrastructure in the poorest areas. This presents two major challenges. The first is related to the higher cost of providing infrastructure, especially to small remote villages, which calls for developing innovative, cost-effective solutions to provide these families with public services. The second is related to poor coordination between sector-based public investments at different levels of government. Studies have shown that there are important complementarities in rural infrastructure investments that can promote market development and economic growth, thereby reducing poverty (Escobal, 2005). A major challenge is to coordinate efforts at all levels to identify shortfalls and provide location-specific infrastructure according to local needs and opportunities.

Another major constraint involves the quality of public services. Poor-quality public education at all three levels (primary, secondary and higher) and inadequate health services are important development issues that should be addressed by a package of programmes aimed at providing equal opportunities and universal access --- increasing quality or quantity in isolation is not enough. Despite the significant expansion of education services over the past decade, Figueroa (2008) asserts that education has not helped to improve equality in Peru. This is mainly because the structures of the political economy reinforce social exclusion. Figueroa sets up a theoretical model based on a society with unequal endowments of economic, political, and cultural assets. He argues that these inequalities play a fundamental role in limiting the potential to equalise education. Political inequalities relate mainly to inequality before the law (not all individuals are treated the same), and define first- and second-class citizens. Cultural assets are defined as the rights to cultural diversity in a multicultural society. Inequality in these endowments generates a hierarchy of ethnic markers in a society.

Social conflict could be another major constraint on future efforts to alleviate poverty and inequality, mainly because it could discourage investment, particularly in the extractive industries. Most social conflict in Peru is triggered by the presence of extractive industries (mining, gas and oil) in areas with high poverty levels and a high concentration of indigenous populations that have traditionally been excluded from the benefits of economic growth and social policies. In other words, the richest areas of


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the country in terms of natural resources are also the areas inhabited by the most excluded populations.

Opportunities to consider

The Peruvian economy is experiencing a period of great macroeconomic success resulting from continuity in fiscal and monetary policies. This provides an excellent opportunity to overcome some of the structural problems discussed in the preceding sections.

A healthy economy, such as Peru’s, provides a favourable environment for promoting productivity and competitiveness in less economically dynamic areas through the provision of adequate services, incentives and government support to span the formal and informal economies, which co-exist in the same nation. Some government programmes are oriented towards these objectives, but they are generally small-scale or inefficient and fail to reflect national policy. There is therefore an opportunity to scale up and improve programmes that promote economic development among the less dynamic sectors of the Peruvian economy.

Created in 2011, the Ministry of Development and Social Inclusion (MIDIS) is a key government body responsible for reducing poverty and vulnerability and for minimising exclusion. It has three main policy goals. The first is to promote equal opportunities by ensuring universal access to services for the rural poor and vulnerable populations through poverty-alleviation programmes that provide cash transfers and support for basic needs. The second is to build the capacities of poorer, vulnerable and excluded populations to enable them to take advantage of economic opportunities. The aim is that social programmes promote income generation, food security and employment by linking poverty-alleviation and social-promotion programmes, thereby enabling the poor to improve their well-being. The third goal is to develop a system of continuous learning and quality control through permanent monitoring and evaluation.

MIDIS inherited three existing programmes and has created two new ones to achieve its goals. JUNTOS is a CTT programme designed to minimise the inter-generational transmission of poverty through developing the children’s capacities and at the same time providing poverty-alleviation support to their families. CUNA MAS provides daytime childcare and family support to improve the integral development of children under the age of three who are living in poverty. PENSION 65 provides cash transfers to poor citizens over 65 years of age, with the aim of reducing vulnerability and enabling families to channel resources into productive activities. FONCODES promotes local development, based on a territorial approach, and covers four areas of intervention: production; capacity building, infrastructure development, and territorial interconnection. Finally PRONAA3 was created to prevent malnutrition, particularly among poor children.

MIDIS is currently working to streamline existing programmes and improve the quality of social services. The main challenges it faces are related to better targeting (by focusing on specific characteristics and needs of beneficiary populations), strengthening interventions using a territorial approach, promoting results-oriented management of public funds, and aligning strategic objectives across social programmes (MIDIS, 2012).

Fewer than 8% of the country’s almost 2 million agricultural units are over 20 hectares in size. In general, these farms are high-productivity companies that make up Peru’s agri-business sector. At the other end of the spectrum are small-scale subsistence farmers who produce for their own

3 After a thorough and high-quality impact review of PRONAA, the government has announced that this large and politically sensitive programme will be terminated by the end of 2012. The decision was widely taken as a very positive sign that quality standards would be applied to social policy. To replace PRONAA, there will be a more efficient programme named Qali Warma (Vigorous Children) to provide adequate food packages for children in public schools, ensuring quality, appropriateness and healthy practices.


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consumption needs and diversify their economic activities to generate a subsistence income. Between these two extremes lies small-scale commercial agriculture, which is made up of agricultural units that rely on family labour and produce mainly for local markets. According to CEPES (2000), this provides 70% of agricultural production and employs about 25% of the country’s labour force. Trivelli, Escobal and Revesz (2006) found that these small-scale farmers are not only economically viable, but also constitute an important source of economic development and contribute to reducing poverty.

Another opportunity is the recently created rural development programme, AGRORURAL, which aims to connect and develop public programmes to improve living conditions in rural areas through the creation of agricultural businesses and rural development projects. AGRORURAL has developed several successful programmes whose interventions demonstrate great scaling-up potential. Most of these projects are participatory and demand-driven, take an overall rural economics approach, promote linkages with markets, address specific bottlenecks and provide long-term capacity building. AGRORURAL is far from being an efficient programme, but it does provide an adequate framework for orienting rural development programmes toward reducing poverty and inequality.

Another important opportunity (which also represents a major challenge) is the expansion of public infrastructure. Although there is still substantial room for improvement, the expansion of telecommunication services, rural roads, electricity, etc., has laid the groundwork for future improvements in market access. Better coordination between different public infrastructure initiatives is key to enhancing economic returns.

2.2.3 Role of external actors

External actors have contributed to reducing poverty through FDI in key sectors that promote economic growth. External agencies have also contributed to competitiveness and poverty-reduction programmes in rural areas. For example, most of the programmes and projects developed by AGRORURAL were supported by agencies such as IFAD, the FAO, the World Bank and the IADB.

Large-scale irrigation programmes in rural coastal areas and now in the rural highlands have been partly funded by JBIC-JICA, the World Bank and the IADB and formed part of a strategy to improve infrastructure in the coastal valleys. Since 2009, most such funds have been devoted to irrigation systems in the rural highlands.

In addition, international aid agencies, international NGOs, bilateral donors, and/or international organisations have funded a large number of NGO-run projects. Most of these projects have been focused on improving the sustainability of production and the competitiveness of small-scale and/or informal rural and urban producers.

It is also important to note the relevance of other Latin American countries, particularly in relation to the development of social policy. Over the past 15 years there has been a new wave of social policy reforms across Latin America. Bolsa Escola --- a scholarship programme for poor families whose children are enrolled in public schools --- started in the Brazilian state of Brasília in early 1995 and was adopted by the federal government as a national programme in 2001. Mexico launched Oportunidades in 1997, a CCT programme to provide equal opportunities for all Mexicans. Families received cash subsidies for food and scholarships in exchange for enrolling their children in school and attending regular health checks. Peru’s CTT, JUNTOS, drew on these two experiences when it was established in 2005.

As shown in Section 1.3., remittances also played a role, although amounting at most to less than 2% of GDP.

As for the future, external agencies can play a role in two main areas. The first is related to opportunities to promote economic linkages between regions and sectors, and the development of


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low-productivity activities. The second is related to the EU’s relative advantages in relation to Peru, mainly in the area of institutional development.

International cooperation for the reduction of poverty and inequality should focus on providing support to the agricultural and informal sectors, and help to create linkages between economic sectors and regions. International cooperation should focus on the most vulnerable sectors, where inefficiency, low productivity, informality and poor opportunities are concentrated. Agriculture remains a key sector that includes the largest proportion of poor households. According to the National Statistics Institute (INEI) it is also the sector with the lowest productivity levels.

Informal markets will also play a key role in future economic development and could benefit from international cooperation. Efforts should be directed towards promoting productivity and creating incentives for formalisation. This will develop a larger tax base and help reduce dependence on a smaller number of high-productivity sectors.

Many of the main challenges to reducing poverty and inequality in Peru relate to structural problems arising from low institutional capacity, weak governance and a lack of human capital. This points to a new orientation for future cooperation between the EU and Peru, which should be focused on the transfer of technology and skills.

The MDGs and National Development Plans

The MDGs do not play a particularly important role in Peru’s social policy. Since 2000, none of the major social policies, poverty-reduction measures or pro-equality initiatives has been inspired by or refers to the MDGs.

First, this is because many of the country’s social policy objectives precede the adoption of the MDGs in 2000. Second, Peru’s recent history (in particular the period 1985---2000 with its hyperinflation and macroeconomic crisis, internal armed conflict, and loss of civil liberties under the authoritarian regime) has spurred a national consensus regarding economic growth, poverty reduction, democratic governance and human rights. In 2002, President Alejandro Toledo approved the National Accord, a set of 31 state policies developed and approved through dialogue and consensus among civil society and the public and private sectors. Policies 10 to 16 are related to poverty, equality and social justice, addressing issues such as poverty reduction, equal opportunities without discrimination, universal access to public education, universal access to health care, access to adequate employment, food security and nutrition, and strengthening of the family unit. Even before that, in 2001 the Mesa de Concertación de Lucha contra la Pobreza (Poverty Action Roundtable) was established to bring together public and private institutions, as well as participants from civil society, to adopt agreements and coordinate poverty-reduction actions.4 Third, the most important sources of ideas and inspiration for the design of social policy came from other relevant Latin American experiences, such as the poverty-reduction programmes in Mexico and Brazil. Fourth, many of the targets defined in the MDGs were not particularly challenging for a country that by 2000 already had a per capita gross national income PPP of USD$4,790 and has subsequently experienced rapid economic and social progress. Finally, the responsibility for keeping track of and coordinating Peru’s progress towards achieving the MDGs was allocated to a government office that had very little political power, a clear indicator that the MDGs had only a minor influence on public policy.

4 It is noteworthy that the founding Social Charter of the Poverty Action Roundtable, signed in May 2001, does not contain one single mention of the MDGs.


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2.3. Environmental sustainability The dynamics of long-term economic growth in Peru are based on the exploitation of the country’s natural resources. The different cycles of expansion and recession, described in classic texts such as Thorp and Bertram (1979) and Hunt (2011), can be explained by analysing the regulations that define access to and control over natural resources. These regulations also explain several of the distributive changes throughout Peru’s economic history. Economic booms triggered by a particular commodity have historically been followed by resource depletion and collapse. Classic examples of this include guano (1850s---1870s), saltpeter (1860s---1870s), rubber (1890s---1910), and anchovies (1960s---1970s). Although mining has remained a key economic activity since colonial and even pre-Hispanic times, the sector has also experienced several cycles of decline with economy-wide impacts.

The most recent cycle of economic expansion in Peru over the last 20 years has also been based on the exploitation of natural resources such as copper, gold, natural gas and fisheries. This time, however, the expansion cycle has been accompanied by the emergence of two new features of public-sector management: the adoption of the National Environmental Management System (Sistema Nacional de Gestión Ambiental --- SNGA) after the creation of the National Environmental Authority (Autoridad Ambiental Nacional) in 1994; and the process of administrative decentralisation (the creation of Regional Governments and new regulations for Local Governments), with several tools to promote citizen oversight. Consequently, Peru provides a number of lessons about the factors that enable or impede the construction of an effective public environmental management system.

This section presents an overview of the main changes that have facilitated or impeded Peru’s progress towards a more sustainable economic pathway. The first part focuses on the internal and external factors that provide the context to this process, emphasising the main policy dimensions tackled by the SNGA, and draws attention to the role played by external agents and by ODA. The second part analyses the principal challenges to and opportunities for Peru to achieve sustainable economic growth and highlights potential areas for international cooperation.

From the beginning of the 1990s into the first decade of the 21st century, debates in Peru about the environment covered four main areas of environmental policy: the ‘green front’ (biodiversity conservation and sustainable management of natural resources), the ‘brown front’ (waste management and contamination control), the ‘blue front’ (education, funding and institutions), and the ‘golden front’ (trade and international relations). These four focus areas provided the framework for the ‘Strategic Objectives’ of the National Environmental Policy, approved in 2009, a year after the creation of the Ministry of Environment. In the following section, we present a brief summary of environmental sustainability in Peru over the last two decades and discuss the main determinants of and constraints on change.


The principal determinants of change originate in Peru’s participation in the global community via numerous international pacts, including various agreements that were reached after the 1992 UNCED in Rio, as well as the Free Trade Agreement with the USA signed in 2006. Donors have played a key role in providing resources and encouraging institutional changes, while the private sector promoted the enhancement of social and environmental regulations during the implementation of the structural reforms. Likewise, the 1990s Investment Promotion Plan attracted several foreign corporations that required a clear legal framework.

Peru has made significant progress towards environmental sustainability, such as signing the National Agreement (Acuerdo Nacional) in 2002, which, in State Policy N°19, affirms national responsibility for the environment and a government commitment to integrate environmental issues into economic,


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social, and cultural policies as well as land-planning tools. Furthermore, civil society, NGOs and other organisations have promoted respect for indigenous people and their traditional knowledge, which embodies a particular reverence for the natural world. It is clear, however, that the external factors relating to compliance with international commitments have been far more important in enhancing the National Environmental Management System.

It is important to note that the current Minister and Vice Ministers of the Ministry for the Environment are professionals whose careers have been dedicated to policy research and environmental sustainability goals. These individuals belong to the academic and NGO communities in Peru (the Minister was previously Executive Director of the Peruvian Society for Environmental Law (la Sociedad Peruana de Derecho Ambiental), one of the main non-profits promoting environmental policy and legislation in Peru.

Constraints to change

While the main constraints to change stem largely from national factors, the lack of enforceable international agreements and policies also plays a key role. In Peru, the main obstacles to environmental sustainability are due to institutional weaknesses within the government. For example, at the macro level the separation of fiscal policy from environmental monitoring creates many inefficiencies arising from conflicts of interest between different authorities. A classic example is the lack of coordination between fiscal and environmental policies on tax charged for oil and gas exploitation, whereby the most polluting gas extraction was assigned the lowest tax rates.

Another institutional constraint that has emerged during the evolution of the National Environmental Management System is the low capacity of regional and local governments, operating without a clear mandate or enough resources to enforce national environmental regulations. This often arises when the central government transfers responsibilities to local governments without assigning them an adequate budget. The case of the Regional Government of San Martin in the northern upper Amazon region is exceptional in having demonstrated a firm commitment to implementing and consolidating a Regional Environmental Management System, and being quite successful in this despite the lack of support from central government.


Main constraints that could affect future development

Over the last 20 years, Peru has made good progress towards establishing a sustainable pathway to development, including measures to protect the environment and natural resources. The government has become stronger in relation to environmental issues, leading to the creation of the Ministry for the Environment in 2008. However, much remains to be done. The main constraints to environmentally sustainable growth are linked to four central themes that affect every aspect of environmental management and natural resource protection: information, financing, security of ownership and political consistency.

The lack of an integrated environmental information system to facilitate the coordination of sectorial policies and the implementation of Land Development Plans creates serious inefficiencies in the management and protection of the environment and natural resources. There is therefore a need to reform and strengthen the National System for Environmental Information (Sistema Nacional de Información Ambiental --- SINIA). Even more importantly, SINIA should be managed through coordinated efforts between the Ministry for the Environment, the Ministry for the Economy and Finance (MEF) and the National Institute for Statistics and Information (Instituto Nacional de Estadística e Informática --- INEI). The SINIA could then become a strategic tool with which to retrieve and build the credibility of the Environmental Management System by promoting the


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valuation of natural assets, consolidating the fiscal (and penalty) systems relating to the environment, and facilitating the implementation of strategic investment projects along with mechanisms for compensation and mitigation.

With regards to project and programme financing, the environment ‘sector’ still lacks the political power to be able to negotiate a high budget allocation. Peru therefore remains dependent on ODA and technical assistance in relation to environmental programmes (see Table 4). The main groups that have pressed for increased resources for the implementation of the National Environmental Policy, such as NGO members of the Peruvian Environmental Network (Red Ambiental Peruana) or that are on the Peruvian Committee of the IUCN, as well as some community-based organisations linked to rural and indigenous movements, do not as yet appear to have the capacity for political representation and participation at the national level (usually achieved through national movements or political parties). Furthermore, variations in the proportion of the national budget assigned to the environment ‘sector’ are largely due to the involvement of certain individuals in public management (as at present) or by pressure applied by multilateral organisations (including the World Bank, the IADB and United Nations specialised agencies).


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Table 2.3 Main actions in 2009 of the strategic thematic area of the PNCTI: sustainable competitiveness

Country Actions Implementing agency Amount in US$ Total per country %

Germany Sustainable Rural Development Ministry of Agriculture 1,409,428

2,818,856 9.6 Programme for Sustainable Rural Development (PDRS)

Ministry of Agriculture 1,409,428

Belgium

Institutional strengthening of the SME sub-sector of the Vice-Ministerial Office for SMEs and industries for the development of policies and instruments for

SMEs

Ministry of Production 74,576

1,097,002 3.7 Programme of non-financial business service centres in the economic corridor Ayacucho -

Apurímac – Huancavelica. Ministry of Production 1,022,426

European Union

Cooperation project between the EU and Peru to provide technical assistance in trade issues and to

provide support to the National Strategic Programme for Exportations,.

Ministry for Foreign Trade and Tourism

4,373,294

16,312,395 55.3 Project providing support to professional training for labour market insertion in Peru. Strengthening

and Expanding – APROLAB II Ministry of Education 11,939,101

Spain

Strengthening local capacities to improve environmental management in the province Loreto

– Nauta -Araucaria XXI. Ministry of the Environment 286,767

4,137,206 9.6

Programme to support artisan fishery, aquaculture and sustainable environmental management

(PROPESCA). Ministry of Production 846,770

Development and strengthening of rural tourism in Peru (TURURAL).


510,623

Programme for Rural Tourism in Peru (TURURAL).


339,642


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Support to the strengthening of agricultural crop exports to improve productive activity.

Ministry of Agriculture 390,453

Integrated Project Araucaria XXI ‘Conservation and Sustainable Development in the North-eastern

Biosphere Reserve (RBNO)’.

National Institute of National Resources

448,214

Strengthening of integrated management in the bi-national water basin Catamayo–Chira.

Regional Government of Piura 708,063

Improving service infrastructure and commercialisation in the department of San

Andrés, Pisco province, Ica region.

National Fund For Fishery Development

606,674

France

Project 5. Structuring and functioning of the pelagic system in the Peruvian upwelling ecosystem.

The Peruvian Sea Institute 38,000

104,939 9.6

Tectonics, geomorphology and erosion in the Andes

The Institute for Geology, Mining and Metallurgy

30,000

Project: Mixed Paleo-oceanographic Research Laboratory (MIXPALEO) in Callao, Peru.


Project 3. High-resolution pale-oceanographic sediment registers in areas with low oxygen levels.


Climate variability and dynamics in the Humboldt current system – observations and modelling.


Italy Sustainable development and management of forest resources in the high zone of the micro water-basin

of the Jucusbamba river in the Amazonas region.

Regional Government of Amazonas

454,068.69 454,068.69 1.5

Switzerland

Climate Change Adaptation Programme in Peru (PACC) Phase I.

Ministry of the Environment, Regional Government of Apurimac and Regional Government of Cusco

1,754,657

4,585,808 15.5 Climate Change Adaptation Programme in Peru

(PACC) Ministry of the Environment 88,290

Programme of Trade Cooperation between Switzerland and Peru (PCC) Phase II


160,619


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Regional Programme for Clean Air Programme (PRAL) Phase I

National Environment Council 675,802

Regional Programme for Clean Air Programme (PRAL)

Ministry for the Environment 623,336

Strengthening and promotion of biodiverse products and services ‘Peru biodiverse’.


1,283,104

Source: APCI (2011)


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A third constraint is the ongoing need for improved ownership security and clearly defined property rights over natural resources. Related to this is the low capacity of regional and local governments for granting such rights. In Peru granting resource rights is based upon a centralised decision-making process, leaving regional and local governments with little or nothing to say, even in the case of land-use planning tools (the current debate on ecological and economic zoning clearly illustrates this point). The 1995 Land Act marked the beginning of an accelerated process of granting property rights over natural resources, which has been carried out in the context of market liberalisation. This process was later strengthened via the Constitutional Law for Natural Resources (1997), the Forestry Law (2001 and a revised version in 2011) and the establishment of individual quotas for anchovy fishing at the end of the last decade. Notwithstanding, this process of liberalisation has faced two constraints. First, poor development of capital markets has meant that the anticipated levels of private investment and growth in the agricultural and forestry sectors have not materialised. Second, a lack of clarity regarding the responsibility of regional governments for granting rights and approving land-use plans has contributed to social and environment conflicts on access to and control over natural resources.

A similar situation of ownership ‘insecurity’ also exists in relation to intellectual property and collective knowledge rights, which are covered in commercial agreements such as the Free Trade Agreement with the USA and, more recently, the agreement signed with the EU. The issue of access to genetic resources has not been properly addressed either in national-level public-sector management or in bilateral and multilateral development aid agreements.

A more structural constraint is the political inconsistency surrounding the implementation of the PNA in 2009. If local communities do not want, or lack the financial resources, to develop natural resources, only large-scale investment can improve the well-being of those living in resource-rich areas, which are traditionally invisible and largely excluded from state presence, how can the ‘dog in the manger’ paradigm be prevented from increasing the distance between the objectives of economic growth and those of sustainable development? To avoid increasing the disparity in well-being across different population groups in Peru, it is vital to address issues such as the redistribution of rents and bonuses for the sustainable use of natural resources, transparency in the use of income generated by natural resources and prioritising the exploitation of non-renewable resources at the expense of renewables.

Main opportunities

There are various opportunities for Peru to develop along a more sustainable pathway, some over the short term and others over the medium and long term.

First, in the context of the new ‘green economy’ paradigm (United Nations Summit Rio + 20), Peru could benefit by driving forward reforms and obtaining the necessary resources to implement them. In particular, Peru could seize the opportunity to participate in different mechanisms to promote payments for ecosystem services (especially carbon markets and water services), as well as exploiting a huge potential for the development of clean production systems in the manufacture sector. Greening the economy will require a range of policies to reduce carbon emissions and promote sustainable production systems both in the natural resource sector and in urban production systems.

At the same time, if the National Environmental Management System is to recover (or start to build) credibility among civil society actors, it will be necessary to implement a system of punitive and compensatory sanctions. The Ministry of the Environment is currently drawing up a new proposal for environmental ‘compensations’ (as distinct from traditional mitigation and replacement mechanisms). A system of penalties for failure to meet the Environmental Quality Standards should be the first step in this direction and should include the institutional reform of the Environmental Management System, modifying the procedure for approving Environmental Impact Assessments (EIA) from the sectorial system currently in place.


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The Peruvian economy could benefit from international development aid in the form of technical assistance to improve information systems. The current example of deforestation monitoring in the Amazon could be replicated in other areas, where economic incentives could be used to induce efficient long-term environmental management. These information systems should be designed to facilitate more efficient coordination between the Ministry for the Environment, the Ministry for Finance, the National Institute for Statistics and the Central Bank. This new ‘recharged’ SINIA could inform several policies, from the consolidation of a multi-sectorial EIA system (including the enforcement of sanctions), to the economic valuation of biodiversity and ecosystem services, and the implementation of Land Use Planning systems at regional and local levels.

Based on the four Strategic Objectives of the National Environmental Policy (PNA), external actors could support research programmes that provide data and analysis for a National Agenda for the Environment.

It is important to highlight the important role that the private sector (especially large foreign corporations) has played in developing and enhancing several social and environmental standards in Peru. Areas demonstrating clear potential for external actors to contribute to improving and consolidating environmental policies include the current debate on the Prior Consultation Law (Ley de Consulta Previa) in relation to development projects in indigenous territories, regulation of involuntary (development-induced) resettlement and the need for a clear definition of local and regional government rules.

As a member of the Organisation for Economic Co-operation and Development (OECD), the EU shares a strategic objective in relation to international development. For the OECD, the central issues for environmental and development policies are capacity development, climate change, green growth and strategic environmental assessment. This represents a clear opportunity for cooperation from the European region to strengthen the National Environmental System, starting with an Environmental Performance Assessment (like the one conducted for Chile in 2005) and leading to direct collaboration in the implementation of key management instruments, such as the Strategic Environmental Assessment (SAE) and Land Use Plans (LUP).

According to data published by APCI (2009) 18% of all non-reimbursable international development aid in Peru --- approximately US$57.68 million --- has been invested in MDG 7 (‘Ensure environmental sustainability’). The next section gives an overview of the role played by the MDGs in Peru’s environmental policies.

The MDGs and National Development Plans

The aims MDG 7 are integrated into environmental policy in Peru including in the National Environmental Policy (PNA, 2009), the Environmental Action Plan (PLANAA, 2010), and the Bicentennial Plan (2011). All of these were designed to respond directly to the policies set out in the 2002 National Agreement (Acuerdo Nacional), and none of them refers explicitly to the MDGs. However, in a broad sense it may be said that these planning instruments aim to achieve several of the MDGs and in particular the aims A, C and D of MDG 7.

In contrast to African and South East Asian countries, policies in Peru have followed the path set out in national policy agreements, such as the 2002 National Agreement, and, its environmental policies comply with international agreements signed following the 1992 Earth Summit.


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2.4. Governance As discussed in Section 2.1, Peru is experiencing a period of almost unprecedented economic growth, certainly since the 1950s and 1960s. After several decades of erratic economic performance, Peru has managed to surpass the GDP per capita it reached between the late 1970s and early 1980s. In the midst of an international economic context that has been relatively favourable for Latin American economies, Peru has performed particularly well, registering higher growth rates and better performance indicators than the majority of countries in the region.

At the same time, Peruvian society manifests the lowest levels of trust in political parties, Congress, the judiciary and the government in general in Latin America and the Caribbean (only the Guatemalans have less confidence in their government). In addition, only 16% of Peruvians believe that the government works ‘for the benefit of the entire population’ and not in favour of a powerful elite. This places Peru among the lowest in the region after the Dominican Republic and Argentina. Finally, Peru is characterised by high levels of social conflict. According to the Americas Barometer, 12% of the Peruvian population participated in protests during 2010 --- a percentage that was only surpassed by only two other countries.

How can this paradox be explained? This section provides an alternative to the dominant discourse, according to which ‘the economy functions well, but politics (weakness of political parties and institutions) and the government do not’, because they lack the capacity to capitalise on the opportunities from growth to resolve national problems. On the contrary, it is precisely these government characteristics that explain both the achievements and the limitations of economic growth, as well as the problems of political legitimacy.

The Peruvian government is largely heterogeneous and its different branches operate under a distinct and sometimes opposing logic. Thus, while a range of reforms, institutions and practices sustain economic growth, at the same time national policy has lost legitimacy within these institutions and in the face of market mechanisms. This is due to extremely low capacity among national policy-makers who, paradoxically, are able to ensure that their poor performance does not affect the pace of the economy. Simultaneously, there is a group of almost ‘abandoned’ institutions, particularly vital for the redistribution agenda, building political legitimacy (of the social and justice sectors), and establishing adequate frameworks for democratic representation. It can therefore be concluded that international development aid is critical for supporting reforms in governance, strengthening the efficiency of public institutions and building the capacity of those who participate in the formulation of public policy.

These conclusions are reflected in the recommendations made in this section, which include a short-term agenda for improving the transparency and openness of public institutions that already demonstrate good governance; a medium-term agenda to complement state reforms in areas that are currently weaker; and a long-term agenda of institutional strengthening, a process of renewal that will take longer to complete. These recommendations are based on the belief that gradual and instrumental institutional reform is more pragmatic than aiming at a systemic transformation of the public sector.


The Peruvian political system has undergone significant changes since 1990, a year that represented a break with the country’s political history, which was characterised by authoritarian and democratic rule alternating almost once every decade, coupled with a fragmented political system. Since then, the political system has been marked in different ways by what happened or stopped happening during the 1990s. Not only were new relationships established between the state, the economy, politics and


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society, while previous relationships dissolved, but also new interest groups emerged that were associated with supervising the validity of these reforms, providing the right conditions for their replication.

These important changes arose from two key factors: a transformation of the prevailing economic model and the establishment of a new authoritative government led by the ‘outsider’ Alberto Fujimori. Fujimori came to power unexpectedly, not belonging to any of the leading democratic political parties of the 1980s. In order to do so, he capitalised on the electorate’s discontent with the political system, which was incapable of coping with the economic crisis --- the exhaustion of a ‘state-centric’ relationship between politics, economics and society (Garretón et al., 2004; Cavarozzi, 1996) --- or of putting an end to the subversive activities of Shining Path and the MRTA. A record annual inflation rate of 7,481% was reached in 1990, one of the highest in world history. The previous year, Peru suffered the second highest number of casualties in any one year of the internal armed conflict.

Faced with this scenario, the Fujimori government initiated one of the most drastic structural adjustment and reform processes in Latin America. The state’s participation in the economy was substantially reduced and institutions were established to support the development of a market economy. Greater independence was granted to the Central Reserve Bank, the National Tax Bureau (SUNAT), created in 1988, was reformed, and the administration of the Ministry for the Economy and Finance (MEF) was modernised. From this time onwards, foreign-educated orthodox economists with strong international networks began to establish a degree of hegemony over important public policy decision-making (Conaghan, 1998).

After the establishment of the Constitution in 1993, regulatory watchdogs were set up to oversee private-sector activities in various areas. These bodies retained institutional independence from the government and their roles were meritocratic and technical. The Ombudsman (Defensoría del Pueblo) was also created and maintained a high level of professionalism and independence from political power throughout the decade. In the future, these institutions became ‘islands of efficiency’ within the Peruvian state. In general, it can be said that these government reforms were driven by the interests of and pressures from domestic and international actors, who formed a coalition committed to implementing and consolidating the newly emerging economic model, and that other areas were overlooked.

Solving the problem of hyperinflation earned Fujimori considerable political support, which afforded legitimacy to his increasingly critical discourse on ‘traditional political parties’ and the restrictions of prevailing institutional frameworks which, according to the official discourse, hindered the exceptional measures required by the dismal state of affairs. These obstacles were removed with the ‘self-organised coup’ (or state of emergency) declared on 5 April 1992, which received broad public support and was consolidated months later with the capture of Víctor Polay (June) and Abimael Guzmán (September) --- leaders of the MRTA and the Shining Path --- resulting in the dismantling of both terrorist groups. With the government at the height of its popularity, a process was initiated to concentrate power in the president. Eventually, this gave rise to an authoritative and very corrupt government, which systematically weakened democratic institutions.

Without a doubt the structural adjustment and reform policies came with high social costs (as evidenced by increased poverty rates) that ultimately threatened the legitimacy of the government. Over time, ambitious social policies were implemented, but these were of a clientelist nature and misused public funds for political ends, benefiting mostly the urban poor. Furthermore, the state regained its presence across the country (it had been dramatically reduced during the 1980s), bringing about significant changes for the population. Control over policy was tightly held by the President via an institution created with this very goal --- the Ministry of the Presidency. Instead of implementing


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the ambitious reforms of the social sector ministries, the government decided to instrumentalise them and bring them under the direct control of the president, along with other sectors.

As a result, the 1990s produced two main outcomes for national governance. On the one hand, a group of government institutions was created that would function in the future as ‘islands of efficiency’. Most of them are involved in managing the economy and work to maintain free-market rules. This helps to explain the dynamics of growth and poverty reduction that have been experienced over recent years. On the other hand, democratic institutions were significantly weakened and the institutional independence of important sectors of the government was curtailed. Political parties and organised social groups were also weakened and this had important consequences in the years that followed. The economic liberalisation agenda placed an emphasis on the reform of several specific institutions, while those not directly linked to the reformist goal were either neglected or fell victim to the concentration of power. Driven by the authoritarian government, these processes eroded the professionalism of numerous sectors thereby creating an obstacle for future governments.

The government of Fujimori ended in November 2000 when he resigned under pressure from the presidency and the Congress declared him morally incapable of performing his functions. Before this, extremely serious cases of corruption under his government had been revealed. With the end of Fujimorism, a new period began for democratic institutions in which there was hope for sustained economic growth but this time with a fairer distribution of wealth. This implied a change in the functioning of political institutions towards democracy, and a different relationship between the state and popular sectors previously subjected to Fujimorist clientelism. The aim was to provide legitimacy to a political system that was based on new foundations. However, this was not to be the case. Although the economy had been growing well --- leading to important reductions in poverty and a relative reduction in inequality --- the high levels of social discontent were visible in the low approval ratings of the President and democratic institutions, and in numerous, fragmented and violent social conflicts. The majority of these conflicts were in rural or semi-rural areas where large-scale extractive industry projects were underway. In fact, private investment has increased at such a rate that weak government institutions have been unable to develop appropriate regulations and controls.

In this sense, the ‘Peruvian paradox’ can be explained by different facets of the current government. From 2000 onwards, Peru’s development was consistently influenced by macroeconomic policy and based on the strengths of several ‘islands of efficiency’. This largely explains national economic growth, as well as reductions in poverty and inequality (to a limited degree). At the same time, the poor legitimacy of democratic institutions and actors can be explained by weaknesses in areas that were never reformed (they remained locked in patterns of patronage and were later captured by different interest groups), in particular those linked to the social sectors and the direct relationship with citizens. The expansion of extractive industries has gained significant importance in the dynamics of economic growth over recent years. Yet growth in this sector has not been accompanied by the development of public institutions capable of mediating the relationships between companies and communities. This has resulted in a growing number of social conflicts. Despite weak political representation and social conflicts, the country has nevertheless remained on the same path. This is due to the weakness and ‘emptiness’ of political activity --- of little importance to technocrats and market mechanisms --- and to the fragmented nature of social protest.


Opportunities

Peru faces diverse opportunities and challenges in relation to strengthening governance. As mentioned, these have been shaped by the political agendas of the 1990s, which favoured certain sectors and neglected others. In order for the country to move beyond its current situation, in which


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the economic model seems to be limping, it is important to seize opportunities and address the challenges over the coming years.

In terms of opportunities, some state sectors observe high professional standards and are relatively efficient. These institutions have played an outstanding role, and have also enabled Peru to benefit from the wave of economic growth throughout Latin America. They have provided the budgetary resources and economic stability that are the backbone to all other processes. Successive governments have not been besieged by crisis or deep economic imbalances and there is consequently now considerably more room for political action than in the past.

Another general opportunity is that in Peru there is a reasonably large consensus (far more marked than in other countries) among the political elite, economists and technocrats about the policies that should not be followed in order to maintain a healthy economy. Although it is acknowledged that the institutional model that sustains economic growth is imperfect and requires modifications (as in the case of managing the extractive industry) there is a broad consensus about the need to avoid reproducing what happened during the 1990s. The trauma created by hyperinflation and the economic crisis has instilled a conservative rationale in society and its elites. Along with the positive growth produced by Peru’s economic model over previous years, this conservatism binds a coalition of interests that is enabling the country to move beyond the ‘pendulum swings’ of the past (Gonzáles y Samamé, 1991). Finally, the extreme limitations of Peru’s political actors have driven public policy-making in certain areas into the hands of experts and technocrats.

Challenges

Although this technocratic consensus has successfully ‘isolated’ the unstable functioning of the economy, the isolation of political pressures has allowed the agenda for redistribution to be evaded and public policy decision-making processes have lost valuable spaces for reflection and transparency.

The state must improve the institutional arrangements for addressing social issues, including specific poverty-reduction policy measures as well as general development sectors such as health and education. Also important in this sense are the security and justice sectors. Institutionalising social issues will require discussions about how to improve the poor distribution of wealth since this has eroded public confidence in the legitimacy of the political system. This lack of trust creates uncertainty during elections and raises the possibility of an anti-system outsider being elected, who would question whether democracy and democratic institutions are a means to improve social well-being. Although this has not yet occurred, it poses a latent risk if there continues to be a high level of discontent about the political system.

A second group of challenges is related to conflict and extractive industries. A large proportion of economic growth in Peru has resulted from the extraction of natural resources, generally in rural areas where poverty is concentrated and the state has only a weak presence. The combination of high-profit investments and weak public institutions that are incapable of exercising credible regulation of extraction activities or of transforming income tax into public goods in an effective and opportune manner, has led to serious social conflicts, some of which have paralysed important projects. Improving this situation depends on improving the institutional arrangements on environmental issues and better regulation of the extractive sector. It is also necessary to tackle weaknesses in the public sector at the sub-national level as these institutions manage a large proportion of the budget generated by extractive industries, as well as from other sources.

The last general challenge relates to the quality of representative institutions. The dismantling of national political forces with the arrival and expansion of Fujimorism (albeit never formalised into a political party) and the fragmentation and historical weakness of political organisations remain the norm at national and sub-national levels. Yet institutional reforms are just only one measure (and


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perhaps not the most important one) for improving this situation and generating a better environment for strengthening political parties. This is why institutional strengthening will require the most long-term vision.

Sector-specific challenges and opportunities

Beyond the more general opportunities and challenges, it is necessary to outline opportunities for reform and strengthening governance within specific sectors. The rationale guiding the identification of these opportunities prioritises measures for incremental and gradual reform that could ultimately lead to the creation of new islands of efficiency in the Peruvian government and the transfer of good governance practices to the entire public sector. The institutions that are considered to be operating well require consolidation and improvements in the short term. Weaker institutions that also provide opportunities for intervention are included in the medium-term agenda. Finally, those sectors and areas where there are few current opportunities for improvement represent long-term challenges.

One area where there are short-term opportunities to improve governance is the strengthening of institutions that work on issues relating to the market economy and its regulation. Institutions such as the Central Reserve Bank, the SUNAT, the MEF, the Superintendent of Banking and Insurance (SBS) and regulatory bodies went through a series of structural reforms in the 1990s, the effects of which can still be seen today. So why do these government bodies function well? Partly because these institutions were reformed under a different logic to the rest of the state and to a greater or lesser extent they all share certain key conditions. The first is that civil servants with higher education are appointed via public competition. Second, these institutions retain financial independence, which means that their budgets are not subject to arbitrary political changes. For example, the regulating bodies receive ‘income per regulation’ directly from companies. Third, these institutions have the administrative autonomy to employ staff without the restrictions of government labour policy. By adopting the same approach to employment as the private sector, they can be more efficient in competing for and attracting talent. Finally, some of these institutions have been strongly influenced by their founders, which has generated a host of institutional arrangements and procedures that are difficult to undo.

Given that these economic institutions function better than the average state body, the challenges of strengthening them are of a different order. There is a need for reforms to make these institutions more transparent and plural and to open decision-making processes to public debate. By hosting a technocratic network with common interests that enjoys a broad consensus with regards to the orientation of public policy, these institutions tend to become isolated from public debate and exchange with the political sphere and civil society. This generates low levels of trust from opposition sectors, which believe that these networks serve only to promote particular interests that are remote from public priorities. At the same time, this isolation generates the perception that these are ‘penetrable’ by private interests. Consequently, it is necessary to improve control mechanisms to avoid possible conflicts of interest and corruption.

An additional challenge is the need to find a balance between the high levels of technocracy in the centralised bureaucracy in certain areas and sectors of the state with the need to improve the quality of human resources in other areas and in sub-national governments. While the central bureaucracy controls areas such as budget allocation, the implementation of public-sector programmes is less efficient. Consolidating these functions (releasing public money and ensuring that it is sufficient to allow government programmes to be implemented) is key if Peru is to take advantage of the economic boom.

A final set of short-term opportunities is based not on institutions that have functioned well over previous years, but on the recent creation of institutions that could become new ‘islands of efficiency’. These institutions should be helped to become more professional and avoid their returning to political patronage. If professionalism, meritocracy and transparency are established from the outset it will be


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more difficult to change these characteristics. The recently created Ministry for Development and Social Inclusion (MDIS) was designed and started out with the participation of academics renowned for their work on social and development issues and highly qualified professionals with experience of working in the other ‘islands of efficiency’. It is worth highlighting the role of ODA in the development of specialists and technical experts in areas related to poverty reduction. While the MDIS is still in its infancy, the coming years will be crucial for determining whether it becomes new example of excellence in public management. This would be a particularly important achievement given that the Ministry would be the first ‘island of efficiency’ focused on social issues.

There is a similar opportunity in relation to the Ministry for the Environment (MINAM), which was created as a result of the 2006 Free Trade Agreement signed between Peru and the USA. It will be vital to strengthen the political and institutional arrangements of this ministry in order to generate public confidence in future extractive industry projects, a sector that will continue to play an important role in national economic growth. Together with the MINAM, the Vice-Ministry for Interculturality, housed in the Ministry for Culture and created by the Ollanta Humala government to facilitate the implementation of the International Labour Organization (ILO) Convention 169, is also a key institution which should receive support to strengthen its independence and professionalism.

The second group of institutions comprises the ones that were sidelined during the reforms or were weakened as power and patronage became more concentrated. These institutions present opportunities and challenges for the medium term. Although many of them have remained gripped by inertia, some have made efforts at reform that could be seized as opportunities. Over recent years, key public institutions (those with a direct relationship with citizens) have consistently made operational errors that have threatened the government’s capacity and legitimacy. The Ministries of the Interior, Health and Education are just a few of those concerned. Similarly, the inefficiency of the judiciary places it among the institutions most subject to public criticism. Opportunities in these cases arise from the presence of actors or initiatives inside or outside these institutions, which should receive support in order that they can function satisfactorily.

Within the judiciary, certain initiatives that have been developed over the years and which continue to be pushed ahead by the current president present opportunities. The most important example is the New Code of Criminal Procedure, which introduces new operational standards for the justice system to improve efficiency and transparency, although significant budgetary and organisational challenges may limit the potential of this initiative, particularly outside the capital.

As well as the adoption of this Code, the current President of the Supreme Court has been pushing for drastic administrative reforms to combat corruption and inefficiency. This is critical for regaining political legitimacy. With this objective, the proposed programme of reforms is intended to strengthen the organisation of the judiciary and the legal profession, including exceptional measures against corruption.

Although this reform programme has not yet been approved and has met with strong resistance from some sectors, it will be critical to take advantage of a general willingness to implement reforms over the coming years. In order for these reforms to be successful, the judiciary must overcome its inertia and dismantle the networks of corruption that have evolved in order to take advantage of the system’s inefficiencies.

Within the judiciary, a major challenge is the re-establishment of basic standards concerning the technical and professional qualifications of government personnel. This is not specific to any one sector but affects the entire state. The emphasis on reducing the role of the state in the Peruvian economy and society meant that these areas were neglected and has led to a kind of paralysis in certain sectors.


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An opportunity in this respect has been created by the Presidency of the Council of Ministers, which has proposed instigating a new process to raise the professional competence of government staff, particularly at sub-national level, through the recently created National Civil Service Authority (Autoridad Nacional del Servicio Civil --- SERVIR). Although the state and government bureaucracy were cut back during the 1990s, no efforts were made to develop a professional civil service, to offer incentives for the acquisition of technical skills or to regain the prestige of public services. The success of the SERVIR initiative is therefore vital in this regard.

The Presidency of the Council of Ministers is also pressing ahead with several initiatives being led by the Secretary for Public Management with the aim of reforming the entire state apparatus. This institution is responsible for reviving the issue of state reforms and has recently promoted the establishment of an Alliance for an Open Government Society in Peru, based on a UN initiative. Its objectives are to promote anti-corruption measures, increase citizen participation and uphold the open, efficient and responsible management of public spending and information. In this sense, the Alliance mirrors a ‘second-generation’ reform agenda and the initiative should therefore be strengthened.

As for specific sectors, it is vital to strengthen dialogue and consensus building between political elites and civil society. Creating spaces for interaction applies pressure on the authorities to assume responsibility for the formulation of public policy and can also spur the development of policy initiatives. Furthermore, the creation and consolidation of these spaces can build participants’ technical capacity, which is then transmitted to the public sector in general. This capacity building is particularly important given that Peru does not have a career civil service. It is important to ensure that Peru generates a clear division in areas of expert knowledge, as other countries do. In this respect, spaces for dialogue should be used to build consensus around public policy and long-term reforms.

One valuable example of dialogue between the government and civil society is the National Education Council (Consejo Nacional de Educación --- CNE). The Council promotes exchange between academics and education specialists with the aim of generating knowledge that can inform the implementation of public policy. The current Minister for Education, Patricia Salas, previously worked for the CNE. Creating more spaces for dialogue and information exchange provides an opportunity for the executive to ensure that public policy is backed by scientific evidence. Given that in Peru expert knowledge is not affiliated with political parties (in the way that it is elsewhere) it is vital to take advantage of these spaces to connect the state with experts and civil society.

As well as the CNE, other similar initiatives include Forosalud in the health sector and the National Agreement. The former Minister of Health previously worked at Forosalud. This reiterates the importance of these institutions as a source of technical knowledge and government staff in a society that does not organise itself around political parties. By strengthening these spaces it is important to seek a similar effect as that described for the education sector.

The final group of institutions that requires long-term interventions and presents challenges rather than opportunities is made up of the Ministry of Defence, in charge of national defence and territorial control, and the Ministry of the Interior, responsible for citizen security. Both ministries lack a high level of professionalism and suffer corruption and operational inefficiencies. In the case of the Ministry of Defence, this is seen in its inability to take control of the Peruvian Amazon region, which remains under the hold of drug traffickers and the remaining members of the Shining Path. This failure is not only due to insufficient equipment and training, but also to corruption, which prevents the armed forces from functioning properly.

The Ministry of the Interior is one of the weakest sectors since the return to democracy in 2000. The intervention of the National Police in social conflicts has demonstrated a lack of the training and equipment vital for maintaining public order. On the other hand, this ministry has also experienced


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the highest ministerial turnover in the last 12 years. Several ministers resigned as a result of allegations of corruption linked to the purchase of equipment and vehicles for the National Police. Even if there are no mafia-like structures in the police, there are some indications of mafia-like behaviour in parts of Peru. It is important to address this challenge so that insecurity, a growing problem in Peru, does not bring a halt to economic and social development processes.

In relation to political representation, there are two areas in particular that present long-term challenges: decentralisation and political parties. Decentralisation, initiated by President Alejandro Toledo in 2003, led to the creation of 24 regions --- political and administrative units that were established in place of the old departments. The medium-term objective of decentralisation was to bring these regions together to establish larger political units. This was intended to reduce disparities between departments and to strengthen fewer territorial units with less fragmented bureaucratic apparatus. This, however, did not happen. Regional presidents enjoy budgetary and electoral incentives that prevent the formation of larger regional units. Likewise, central government has decided against an ambitious reform of the current system due to the political and social costs of reversing institutional arrangements that are already in place. Regional governments have spontaneously created the Assembly of Regional Governments, whose importance has grown and has facilitated negotiations with central government on several important bilateral initiatives. Notwithstanding, creating larger regions and improving the quality of public management in these areas will be vital for converting taxes into social well-being over the coming years.

Decentralisation was supposed to give the political system greater legitimacy and bring the state closer to its citizens. Yet the processes of decentralisation have increased the fragmentation of the political landscape, heightening problems in management, efficiency and redistribution such as the allocation of resources via taxes and other mechanisms. Ten years on from the start of the process, the current situation makes it necessary to re-think the logic behind decentralisation.

Political parties constitute perhaps the largest political deficit in Peru. During the past 20 years many countries in Latin America have undergone political transformation while others have seen their political systems collapse completely. Peru is an especially dramatic example given the depth of its collapse in the 1990s and the incapacity of the governments since then to establish even a moderately stable alternative system of political representation.

The weakness of political parties and its impact on governance has been the source of much academic and political debate. Despite this, there is no consensus regarding the institutional reforms best suited to strengthen political parties. Among existing proposals are the elimination of the preferential vote for Congress, the obligation to hold competitive internal elections open to the public, the creation of uninominal constituencies for the election of parliamentarians, the introduction of additional requirements for the legal registration of political parties and public financing of political parties.

Although some of these measures are underway, political party reform does not depend only on long-term institutional processes. Proposals for strengthening governance in Peru cannot afford to wait for institutional reforms to be completed and should therefore prioritise other areas of politics in order for public management and governance to continue to improve despite the weakness of political parties. It is certain that reconstructing the system of political representation will take many years. Yet measures can be taken to improve relationships between political parties as well as defining public policy and strengthening think tanks (private research centres and universities) which are indirectly linked to certain political orientations and whose leaders often end up in public management.


Unfortunately, bilateral and private European development aid has not placed an emphasis on addressing these issues, although US agencies and entities have played a leading role in strengthening


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governance in Peru. In general, the USA has exercised far greater influence over certain areas of debate and institutional reform, thereby increasing its own political power. It is desirable, therefore, that the Peruvian government access alternative sources of development aid in order to face future challenges in a broader, more plural and sustainable manner.


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3. Conclusions In 1990, Peru was a LIC with high levels of poverty and inequality, the economy was in pieces, emigration was widespread, democratic rule was weak, and an internal armed conflict raged on, taking over 70,000 lives in total. Twenty years later, the current reality would surprise even an optimist. Peru’s macroeconomic indicators stand out among those of the seven largest countries in Latin America (LA 7). During the past decade, Peru has had the highest growth and lowest inflation rates of all countries making up the LA 7. Peru has the highest investment/GDP ratio of any of the LA 7 and its potential GDP growth over coming years is expected to continue to lead regional growth. In the area of trade, Peru unilaterally lowered its tariffs and signed free-trade agreements with most of its trading partners, including the USA, the EU, China and Japan. Although there was significant emigration during the 1980s and 1990s, this is decreasing with the rise in the demand for labour in Peru. Remittances from emigrants are expected to represent about 1.1% of total GDP in 2012. In the area of finance, the balance of payments capital account is open, with a regime of free entry and exit. In recent years, there has been significant FDI in Peru, some of it speculative capital. At the same time, sound economic management has decreased the need for external public financing.

Yet despite rapid and important economic and social progress over recent years, high poverty rates (particularly in rural areas) and income inequality persist in Peru, the latter largely stemming from significant inequalities in opportunities, as well as the low quality and limited coverage of public services. There are major structural differences between economic development on the coast, in the highlands and in the Amazon region. The coastal cities are the most developed and dynamic, while the rest of the country shows very modest levels of development. Because of the vertical and horizontal disparities in opportunities and well-being, Peru actually takes two different forms --- one Peru is making rapid progress along its development pathway, while the other lingers behind with far fewer economic and social changes.

Peru is still in a capital-driven growth phase. As a result, the ratio of capital to labour is expected to increase over coming years, as are employment and salaries. Once this process ends, however, structural factors will become more evident and slow the pace of economic growth. The country’s low international competitiveness, weak institutions, poor quality public services, and weak political governance (including dimensions related to effective political decentralisation and sustainable environmental and natural resource management) could hinder the progress of a country that is considered one of the region’s macroeconomic stars.

Thankfully, the macroeconomic strengths noted above provide the room to design and make substantial improvements in public services, particularly infrastructure for development (transport, water, energy etc.), education, health and public safety services.

Strong economic performance has been accompanied by poor political legitimacy and social conflict, a trilogy resulting from the character of the state and its institutional limitations. The reform of state institutions and support for actors that participate in the formulation of public policy are therefore both critical.

In Peru, international development aid has tended to be channelled towards the social sectors, as is common in LICs. Yet the current state of affairs in Peru as a MIC indicates that the ‘paradox’ described is in fact the manifestation of the so-called ‘trap’ which threatens many middle-income countries: dual and fragmented structures have been strengthened, which prevents the country from capitalising on its existing progress. This means that there is significant potential for technical cooperation to support the institutional strengthening of public services --- particularly education, health, internal security and justice --- as well as areas related to the civil service. These are sectors in


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which the EU demonstrates high standards of performance that could serve as a guide for pending reforms in Peru.

From this perspective, a discussion of future scenarios calls into question how long this ‘paradox’ can survive and how it can be resolved. Will the dynamics of economic growth make it possible gradually to overcome institutional and political problems? Or, on the contrary, will they be intensified by the dynamics of growth, thereby driving up poverty rates once again? Without important institutional and political reforms, it is most likely that the paradox will be maintained precariously for several years, with the occasional threats of regression to the old format, despite the growing importance of the middle class and their efforts to improve opportunities for their children. The necessary reforms are more likely to happen if political and social actors and international development agencies begin to prioritise these governance goals.

Recent advances in the theory of economic growth show the importance of public institutions in increasing productive capacities by resolving active constraints on growth during each period of development. It follows that key areas to be addressed in Peru include strengthening the government’s capacity to manage the exploitation of natural resources (a major driver of economic growth) and responding to calls for effective delivery of public services, or redistribution in general, which directly affect society’s ability to reduce a diverse range of inequalities. If action is not taken over the coming years, the Peruvian economy may be unable to sustain the growth rates of the past decade and sooner or later growth will slow down in the coming ten years.

The rapid insertion of Peru into the international domain played a significant role in driving and facilitating progress, not only in economic terms but also by strengthening environmental governance, restoring the rule of law and respect for human rights, and moderating political differences. Europe, like other regions and countries, was influential in those transitions.

Europe could in future make an even larger contribution to Peru’s development, if (and perhaps only if) it recognises that the axis of cooperation needs to shift in a very fundamental way from technical and financial support for quite basic development objectives, towards broader and fuller economic, political and cultural relations. In particular, Europe represents an important source of ideas, and technical and political expertise, as well as financial aid, all of which could assist Peru in dealing with some of its major challenges, most importantly:

Institutional development and democratic governance Provision of high quality public services to its citizens Reducing structural inequalities

Certainly it would not be possible for Peru to find appropriate support and cooperation for all or most of these priorities from China, the rest of Latin America, or even the USA. For example, one cannot look to China on issues of democratic governance, or to the USA for ideas on national health systems or reducing inequalities; there are areas in which Europe has long been seen in Peru as a reference point or as a source of inspiration and expertise.

The MDG framework was not particularly important as a source of inspiration or guidance for national development objectives and initiatives. When the MDGs were ratified, Peru had essentially already built the basic consensus that has shaped national and sectorial strategies over the past two decades. If anything, Peru recognised its own objectives in some of the MDGs, which informed Peruvians recognise as an important global political statement, although they did not play a significant role in orienting policies or budgets in Peru.

A new framework for international cooperation should consider the differences among developing countries as well as each country’s internal heterogeneity. Poverty will remain a problem, but new


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challenges will also emerge including how to support the formerly poor to reach middle-class status and fully exercise their rights as citizens --- crucial for reaffirming people’s preference for democracy and for fending off authoritarian rule (the latter may prove a greater challenge than the former).

Looking to the future, it is clear that a new international consensus on development will serve Peru well only if it is based on a clear recognition of the realities of middle-income countries. This is already the situation of almost 100 countries in which 75% of the world’s population and over 70% of the global poor live. Middle-income countries therefore represent the main arena of international development from 2015 and beyond.

In addition, Peruvians and successive governments of Peru would probably like to see development agreements that address global public goods, that is, objectives that affect all countries irrespective of their economic status. Issues such as trade, climate change mitigation and adaptation, regulation of financial systems, international migration, and global inequality, should feature prominently in a new post-2015 development agenda, with goals and obligations for all countries.


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